Friday, February 24, 2012

Buffett on Stock Valuations

On quite a few occasions in recent years, Warren Buffett has made it clear that he is having no trouble finding attractively priced stocks.

With that in mind, consider what he was saying about equity prices during the early 2000s.

What follows is just a few samples (among many) of what he was saying back then about stock valuations.

Here's what Buffett wrote in the 2001 Berkshire Hathaway shareholder letter:

Charlie and I believe that American business will do fine over time but think that today's equity prices presage only moderate returns for investors. The market outperformed business for a very long period, and that phenomenon had to end. A market that no more than parallels business progress, however, is likely to leave many investors disappointed, particularly those relatively new to the game.

He added the following in the 2002 letter:

Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge.

The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks – if they can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translate to 6½-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity.

And in the 2003 letter...

We are neither enthusiastic nor negative about the portfolio we hold.  We own pieces of excellent businesses – all of which had good gains in intrinsic value last year – but their current prices reflect their excellence.  The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble.  If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher.  So do I.

Quite a contrast to Buffett's bullishness in recent years when it comes to equities. As far as returns go the decade or so that followed the above comments was, of course, a very tough one.

Here's just one example of his favorable view of stock valuations. Buffett said the following back in 2010:

It's quite clear that stocks are cheaper than bonds. I can't imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they, the lack of confidence. But that's what makes for the attractive prices. If they had their confidence back, they wouldn't be selling at these prices. And believe me, it will come back over time.

Long periods of inactivity is a required part of the investing process. So patience is necessary but, these days, it's not difficult to find shares of quality businesses selling at prices that provide a decent or better margin of safety.

Who knows how stock prices will fluctuate in the next week, month, or even a few years but at least now it's much easier to buy shares of businesses below intrinsic value.

For investors in common stocks, the probability of above average long-term returns seems substantially better now than it was in the early 2000s.

When quality finally sells at a comfortable discount to value my preference is to buy meaningful amounts. I do that with an understanding that it's essentially impossible to gauge the near term stock price movements. In other words, I know the stock may get even cheaper but attempting to time things perfectly leads to errors of omission.

Better to focus on price versus value and ignore the market noise.

Adam

Long position in BRKb established at lower prices
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