Friday, November 25, 2011

Buffett on Europe: Investing While Uncertain - Part II

"The world's always uncertain. The world was uncertain on December 6th, 1941, we just didn't know it. The world was uncertain on October 18th, 1987, you know, we just didn't know it. The world was uncertain on September 10th, 2001, we just didn't know it." - Warren Buffett on CNBC

In this earlier post, I highlighted some of Warren Buffett's thought on Europe from an interview on CNBC.

During the interview, Buffett said he sees Europe as having a fundamental flaw.

In a separate CNBC interview, he also said that the current system they have is not working and even has doubts about the euro survival.

His response to this very serious and developing situation in Europe has been fairly straightforward...to buy stocks aggressively.

Buffett explained some of his thinking when it comes to making investments in this kind of uncertain environment:

"...there's always uncertainty. Now the question is, what do you do with your money? And if you—the one thing is if you leave it in your pocket, it'll become worth less—not worthless—worth less over time. That's certain—that's almost certain. You can put it in bonds and then you can get a certain 2 percent for 10 years and that's almost certain to be less than the decline in the purchasing power."

He later added...

"It's very interesting to me, if you own a farm and somebody said, you know, Italy's got problems. Do you sell your farm tomorrow? If you own a good business locally in Omaha and somebody says Italy's got problems tomorrow, do you sell your—do you sell your business?"

and...

 "...But for some reason, people think if they own wonderful businesses indirectly through stocks, they've got to make a decision every five minutes. So I do not think if Ben Bernanke comes up and whispers to me that he's going to do X, Y or Z tomorrow, I'm not going to change my view about what businesses I want to own."

Yes, Europe may not be a stable situation and it is not clear if the resolution will be orderly or not.

Yes, stocks will probably continue to go down if it goes badly over there.

Maybe, dramatically so.

Understandably, most do not want to watch something they just bought "cheap" get cheaper but, with stocks, that risk is always there and as Buffett points out above, it's not always the risks that are on the radar that cause the disruption.

Good businesses can withstand tough times and the best get stronger during the process even if price action gets really ugly. Many businesses during the last financial crisis made themselves stronger and intrinsically worth more. Share prices eventually follow.

The possibility or even likelihood that Europe will go very badly doesn't change whether part ownership of a good business makes sense when selling at the right discount to value. Margin of safety, as always, is key.

In the long run, it's generally the price paid relative to value, long-term compounding effects, low frictional costs, and the making of quality choices that dictates returns...not the macro stuff.

Later in the CNBC interview...

"I'm going to own these businesses five or 10 or 20 years from now and they'll be all kinds of good news and all kinds of bad news, but the good businesses, they do wonders for you over time."

None of this applies to money needed in the short or even medium run.

As the Europe situation develops, chances are shares in a good publicly traded business, even if bought with a margin of safety, will get cheaper for an extended period of time.

Yet, while near price action may head south, shares of a sound business (if judged correctly) is likely to be worth lots more in 10 or 20 years.

Why sell?

Besides, the lower prices just provide a chance to own more of the business at a discount.

As Buffett says, a farmer wouldn't sell productive farmland in Nebraska because Europe can't its act together. A true long-term shareowner will ignore the daily quotes and focus on things like: Can the business produce long-term high returns on capital? How substantial is the economic moat? Can it be built into something more robust over time? Is management honest and capable?

I think Buffett's belief that Europe may end up going very badly and the fact that he is buying so aggressively still baffles some. It shouldn't be surprising when considering how he has approached things over the years.

Shareowners need to worry about the quality of their business judgment not whether the stock market price will be up or down next week, month, or even year. I know this flies in the face of the many increasingly popular short-term trading strategies but the approach when applied well is a sound one.

In fact, maybe if more participants had a long-term value orientation, and fewer had a short-term technical/algorithmic orientation, maybe we'd have slightly less hyperactive markets.

Intrinsic value, doesn't fluctuate anything like the price action we see.

Those grounded first and foremost by value know it and their buy/sell behavior, if it made up a greater percent of volume, would likely be less about reacting to the next headline and gaming short-term price action. It certainly couldn't hurt though I realize markets will always have a tendency to be alternatively manic and depressed by nature.

The mood swings aren't going away.

Still, if participants with a long-term value bent were placing more of the votes in the short-term voting machine that is the stock market, it seems clear that the nature of price action as a whole would, to a meaningful degree, change. To me, it'd be a welcome culture change for capital markets that, considering entrenched interests, has just about zero chance of happening anytime soon.

The market still functions effectively as a weighing machine over the long haul but I think it is fair to say it need not be this hyperactive and dysfunctional in the short run.

There's plenty of room in the markets for speculation but the proportion matters.  There are many capable long-term investors but having a disproportionate number of participants with little more than a passing interest in things like intrinsic value can't be a good thing.

For some, intrinsic value probably seems little more than a quaint concept as they proceed to read the tea leaves via some chart that supposedly has a head-and shoulders-double-wishbone-cup-with-handle or whatever formation.

The capital markets primary reason for existing to effectively allocate capital. To me, there's little doubt it would function better if more of its participants were grounded more by making judgments of long run value less by gaming price action. That kind of change may create less opportunities for individual investors to profit from extreme mispricing, but the system would become less prone to capital misallocation.

It would also likely behave in a more stable manner which can't hurt business and consumer confidence.

Adam

Related posts:
Buffett Doubts Euro Survival, Views European Stocks Favorably
Buffett on Europe: Investing While Uncertain
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