Friday, October 28, 2011

Buffett: "Disinvestors Lose As Market Falls -- But Investors Gain"

Warren Buffett wrote the following in the 1997 Berkshire Hathaway (BRKa) shareholder letter:

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves. 

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices. 

Now, consider this headline from yesterday:

US Stocks Soar In Global Market Rally As Investors Cheer European Pact

Well, a trader who is long may want to cheer but certainly not an investor.

Anyone investing for the long haul should logically cheer just the opposite. More from the letter:

For shareholders of Berkshire who do not expect to sell, the choice is even clearer. To begin with, our owners are automatically saving even if they spend every dime they personally earn: Berkshire "saves" for them by retaining all earnings, thereafter using these savings to purchase businesses and securities. Clearly, the more cheaply we make these buys, the more profitable our owners' indirect savings program will be.

Furthermore, through Berkshire you own major positions in companies that consistently repurchase their shares. The benefits that these programs supply us grow as prices fall: When stock prices are low, the funds that an investee spends on repurchases increase our ownership of that company by a greater amount than is the case when prices are higher. For example, the repurchases that Coca-Cola, The Washington Post and Wells Fargo made in past years at very low prices benefitted Berkshire far more than do today's repurchases, made at loftier prices.

At the end of every year, about 97% of Berkshire's shares are held by the same investors who owned them at the start of the year. That makes them savers. They should therefore rejoice when markets decline and allow both us and our investees to deploy funds more advantageously.

So smile when you read a headline that says "Investors lose as market falls." Edit it in your mind to "Disinvestors lose as market falls -- but investors gain." Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: "Every putt makes someone happy.")

We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence.

The S&P 500 index has rallied from a low of 1,074.77 to a close of 1,284.59 yesterday, a 19.5% move off the intraday bottom on October 4th.

Many individual stocks are up much more from their recent lows.

At what level is it easier to find undervalued equities and make a long-term investment in shares of a good business?

The answer is obvious yet, for whatever reason, when it comes to stocks it is rising prices that get "cheered".

With everything else, from buying burgers to cars, it is falling prices that get the favorable reaction.

Adam

Long BRKb

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