Wednesday, September 22, 2010

Buffett: The 'Disguised Bond'

In this 2001 Fortune article, Warren Buffett elaborates on how he never knows what any stock will do in a short time frame like 2-3 years.

This is at least mildly interesting since the average holding period for stocks from the early 1930s to late 1970s was 4-8 years. Then in the 1980s it dropped below that range and now has fallen to more like 6 months. Much less than than the time frame Buffett thinks it's possible to reliably know how a stock will perform.

Buffett also essentially says that it's not necessary to know what a stock is going to do in the short run to be successful in investing. Forecasting near-term movements may be impossible, but it is possible figure out, within a range, what a stock is likely to be worth over the longer term.

He also explains why a basket of stocks like the Dow, for example, can be thought of as a 'disguised bond'.

From the article:

"Let me explain what I mean by...'disguised bond.' A bond, as most of you know, comes with a certain maturity and with a string of little coupons. A 6% bond, for example, pays a 3% coupon every six months.

A stock, in contrast, is a financial instrument that has a claim on future distributions made by a given business, whether they are paid out as dividends or to repurchase stock or to settle up after sale or liquidation. These payments are in effect 'coupons.' The set of owners getting them will change as shareholders come and go. But the financial outcome for the business' owners as a whole will be determined by the size and timing of these coupons. Estimating those particulars is what investment analysis is all about."

Buffett then adds, at least when it comes to individual stocks, the real challenging part is figuring out what those 'coupons' are going to be.

Considering this challenge, the fact that so many market participants focus on the short-term -- what James Montier calls the "investment equivalent of attention deficit hyperactivity disorder" -- seems like a rather unfortunate use of time and energy.

Adam

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