Tuesday, September 13, 2011

Buffett Buys "Too Early", Again

It's worth noting that Berkshire Hathaway (BRKa) bought more common stocks in the most recent reported quarter than any quarter since the 3rd quarter of 2008.

Berkshire bought $ 3.6 billion of stock in the most recent quarter. The last time he bought more was in the third quarter of 2008.

Bloomberg:
Buffett Bet on Stocks Before Rout by Spending Most Since 2008

For the first time since 2009, equities exceeded fixed-income purchases. Back in 2008, it turns out Buffett was buying "too early" as stocks would go on to drop even more.

Well, Berkshire's most recent 2nd quarter 2011 buying spree was completed before many stocks recently took a further beating.

If you look closely at Buffett's history you'll see this buying "too early" (and selling "too early" at times for that matter) behavior is far from unusual.

Some seem to think otherwise.

Here's one example. It is an excerpt from this 2001 Fortune article by Buffett:

Previous post: Buffett: The Disguised Bond

"In 1979, when I felt stocks were a screaming buy, I wrote in an article, 'Pension fund managers continue to make investment decisions with their eyes firmly fixed on the rear-view mirror. This generals-fighting-the-last-war approach has proved costly in the past and will likely prove equally costly this time around.' That's true, I said, because 'stocks now sell at levels that should produce long-term returns far superior to bonds.'"

Later in that article Buffett continued with...

"Now, if you had read that article in 1979, you would have suffered--oh, how you would have suffered!--for about three years. I was no good then at forecasting the near-term movements of stock prices, and I'm no good now. I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two. 

But I think it is very easy to see what is likely to happen over the long term."

In his 1965 partnership letter, Buffett explains that in a well-selected concentrated portfolio "the chance of serious permanent loss of capital is minimal", but makes the point that "anything can happen on a short-term quotational basis".

So, in the long run, a concentrated portfolio has a better chance to produce above average results if shares are bought at a sufficient discount to value and intrinsic value* is estimated reasonably well. That doesn't mean that on a "quotational basis" things won't look ugly for quite a while. Things that get cheap tend to get more cheap (just as overvalued businesses in the late 1990s got even more overvalued).

The key is conviction. If an investor lacks conviction in the price paid relative to value it will likely become impossible to handle the sometimes not all that temporary (especially by the hyperactive trading standards these days) paper losses.

Portfolio concentration and sometimes buying "too early" means short-to-intermediate-term results will bounce around more. Some would say that makes the portfolio more risky.

The tendency toward what may seem extreme concentration is the Buffett way.

"The strategy we've adopted precludes our following standard diversification dogma...We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it." - Warren Buffett in the 1993 Berkshire Hathaway Shareholder Letter

Superior performance at lower risk from: 1) intrinsic value being judged consistently well, 2) shares bought at the largest possible discount to that value (conservatively estimated), and 3) a concentration on one's best ideas.

Doing these things in combination is a simple idea that, in the real world, is just not that easy to do. It's less to do with intellect and more about having the right temperament and discipline.

These days the size of Berkshire prevents the same kind of portfolio concentration that Buffett used to employ. Still, consider that two stocks, Coca-Cola (KO) and Wells Fargo (WFC), typically still make up roughly 30-35% of the current equity portfolio.

Adam

Long BRKb, KO, and WFC

* There is no such thing as a precise intrinsic value. It's really an approximation or estimated range of value.
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