The Christmas Gift of Buffett

I recently read a book about Warren Buffet, called Buffet, Making of an American Capitalist, by Roger Lowenstein, which was published in 1996.  Warren Buffet is one of the most successful investors in history.  He is often referred to as “The Oracle of Omaha” and has at times been the richest person in America.  Over 31 years, from 1965-1996 shares In Berkshire Hathaway (Buffett’s investment company) grew at 27.68% per annum.  The Dow Jones Industrial Average grew at 10.31% and the Standard and Poors 500, 10.7%.  Put another way, if you invested $10,000 into Berkshire Hathaway in 1965 it was worth $17,800,000 in 1996.  The same investment into the S&P 500 would be worth $224,000.

The book was an excellent read, not only for the insight into how he invested but also how he operated as a person and as a businessman.  I have summarised my key learnings below.  Given how the markets are behaving at the moment, these learnings are very relevant today.

Value and Growth Shares

Buffet was a student of Ben Graham who wrote “The Intelligent investor”.  He was known as the father of value investing.  Basically, value investing involves seeking out companies that are trading at a discount to their book value.  That is, if you added up all the assets the business holds and then added up the value of all shares, where does the share value sit?  If it sits below the value of the assets, then the company is a good buy.  Other valuations can be used as well, but for simplicity I’m just using the price to book value.

Buffet took Graham’s teachings one step further.  He took the value approach and applied it to future earnings.  For example, Coca Cola.  In 1988 Buffet started buying “case loads” of Coca Cola shares.  Coke shares had been cheaper before and Coke had blanketed the world.  However, Buffett had watched Coke for years.  The company was adrift with international sales being left to individual bottlers, some of whom were not up to the job and Cokes investments were “uncola” like. Coke was taken over by a new CEO who impressed Buffett.  With the change in management and the name recognition Coke had, Buffet felt Coke was then selling at a large discount to future value.  As a result of Buffett’s investment, Berkshire Hathaway’s stock grew 66% in 6 months.

Conviction

As a student of finance, I have learnt about the efficient markets hypothesis.  Basically, it concludes that all information that is available about companies is reflected in the share price and that there is no way you can beat the market.  Any news will instantly be reflected in share prices.  Based on this we have seen the growing demand in passive index funds.  What this means is that you hold an entire market like the NZX50 and replicate it in your portfolio.

Buffett rails against this.  Throughout the book, it gives examples of him buying shares cheaply.  Often, when others are selling.  The market may be efficient, but investors are not rational and often will sell because the price is dropping or because others are.  This is the time to be buying.  There were long periods where Buffett didn’t participate in the market as he believed values were too high.  All the while others were buying anything they could.

Long Term

Buffett went against the latest trends in Wall Street.  Avoided penny stocks, junk bonds, pump and dump strategies and other investment options.  His view was simple.  Look for shares in companies that were cheap, or cheap against their future earnings and buy and hold to benefit from future gains.

Ethical

Early in his career, Buffett set the tone for how he wanted to operate.  He bought shares in American Express after it got into trouble with one of its subsidiaries engaging in dodgy dealings with another company that saw it take ownership of sea water rather than salad oil.  Fraud had been committed against it.  The share plummeted and he scooped the shares up.  Buffet listened to the CEO at the time explain that Amex would stand behind all claims.  Commentators thought it would be the end of Amex.  However, Buffett knew the business was about trust and while the short-term effect of the situation would be harmful to the share price, the company would survive and thrive due to the CEOs response.  There are other examples where Buffett personally got involved to assist companies in working their way out of dodgy dealing by rogue employees.  These are situations he could have simply walked away from like so many on Wall Street may have.  Instead working through the issues saw the companies survive and in the case of American Express, thrive.

If you are looking to invest, talk to us about getting some advice first.  It would be very hard for an individual to achieve what Buffet has achieved.

From Tony Alexander, Independent Economist

Mortgage rates might have peaked – maybe

All of the monthly surveys which I have run since the Reserve Bank tightened monetary policy on November 23 have shown a stepping back of buyers from the residential property market. The presence of investors has broadly gone back to the low levels which have been in place since the end of April 2021 when the tax rules changed.

For first home buyers the surge in worries about the economy has caused their sentiment to step back to near mid-2022 levels. The question is whether they will stay away. Feedback from real estate agents is that the first home buyers do remain interested but need to run their numbers again following the extra 0.5% increase in fixed mortgage rates after November 23.

Going in their favour is the slight loosening of bank lending criteria underway as banks can see that falling house sales mean they are not going to meet this year’s sales targets. There is also a 90% chance in my estimation that current fixed mortgage rates will be the peak for this cycle.

Evidence of weakness in the economy is now coming thick and fast though with an offset to some degree from the unexpectedly strong surge in inbound tourism which contributed to the economy jumping ahead by 2% in the September quarter.

Offshore it is increasingly looking like inflation rates have peaked. But central banks are making it clear that they still see work needing to be done to get inflation down around 2%. The same applies in New Zealand and our central bank is unlikely to start cutting the official cash rate from the probable peak of 5.5% until the first half of 2024.

Before then the medium to long term fixed mortgage rates are likely to be edging lower as their levels reflect expectations of things in the future rather than inflation and monetary policy right now.

Huge uncertainties remain about world and domestic economic growth, inflation rates, and therefore interest rates. Borrowers should take this uncertainty into account when considering the spread of fixed rates to take which will best manage the risk which they can tolerate. Merry Christmas everyone.

For additional information on the economy, housing market, and interest rates, you can subscribe to Tony’s free weekly Tony’s View publication at www.tonyalexander.nz

We’d like to thank you all for your support over 2022.  It’s been a challenging year and 2023 look like it will start off in the same way.  We’re not going to make any bold predictions but when things are good, it doesn’t last.  When things are bad it doesn’t last.  We hope you have an enjoyable and relaxing festive season and look forward to catching up in 2023.

We’ll be closed from Friday the 23rd of December through to Monday the 9th of January.

Disclaimer:  This blog is meant to be informative and engaging, hopefully not a cure for insomnia.  Please don’t take this as personalised financial advice.  Discuss your situation with an Advisor.  This is where I need to say past returns are no guarantee of future returns.