Friday, September 29, 2017

Buffett on American Business

From the Berkshire Hathaway (BRKashareholder letter released earlier this year:

"Our efforts to materially increase the normalized earnings of Berkshire will be aided – as they have been throughout our managerial tenure – by America's economic dynamism. One word sums up our country's achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.

You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776."

And later Warren Buffett writes that...

"American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.

Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: 'We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.'

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well."

So, essentially, those with a long investing horizon who view favorably the equity markets hitting new highs have it backwards.

Buying stocks when they sell near their full intrinsic per-share value -- or, worse yet, above a conservative estimate of that value -- simply increase their risk of loss and reduce forward returns.

"We hear it all the time: 'Riskier investments produce higher returns' and 'If you want to make more money, take more risk.'

Both of these formulations are terrible. In brief, if riskier investments could be counted on to produce higher returns, they wouldn't be riskier." - Howard Marks in his memo: Risk Revisited

"If you buy a dollar bill for 60 cents, it's riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case. The greater the potential for reward in the value portfolio, the less risk there is." - Warren Buffett in The Superinvestors of Graham-and-Doddsville

Prevailing wisdom may suggest otherwise but, at least for investors, risk and reward need not be positively correlated.

Frequently misunderstood and underutilized.

American businesses, in the long run, will likely do just fine and their long-term owners have a relatively uncomplicated way to tilt the relation between risk and reward in their favor.

Those who, by and large, are investing with eye toward many years down the road should be hoping that stocks get cheap again.

Adam

Long position in BRKb established at much lower than recent market prices

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