Pension-fund managers continue to make investment decisions with their eyes firmly fixed on the rearview mirror. This generals-fighting-the-last-war approach has proven costly in the past and will likely prove equally costly this time around.
Stocks now sell at levels that should produce long-term returns far superior to bonds. Yet pensions managers, usually encouraged by corporate sponsors they must necessarily please ("whose bread I eat, his song I sing"), are pouring funds in record proportions into bonds.
Meanwhile, orders for stocks are being placed with an eyedropper. Parkinson--of Parkinson's law fame--might conclude that the enthusiasm of professionals for stocks varies proportionately with the recent pleasure derived from ownership. This always was the way John Q. Public was expected to behave. John Q. Expert seems similarly afflicted. Here's the record.
In 1972, when the Dow earned $67.11, or 11% on beginning book value of 607, it closed the year selling at 1,020, and pension managers couldn't buy stocks fast enough. Purchases of equities in 1972 were 105% of net funds available (i.e., bonds were sold), a record except for the 122% of the even more buoyant prior year. This two-year stampede increased the equity portion of total pension assets from 61% to 74%--an all-time record that coincided nicely with a record-high price for the Dow. The more investment managers paid for stocks, the better they felt about them.
And then the market went into a tailspin in 1973-74. Although the Dow earned $99.04 in 1974, or 14% on beginning book value of 690, it finished the year selling at 616. A bargain? Alas, such bargain prices produced panic rather than purchases; only 21% of net investable funds went into equities that year, a 25-year record low. The proportion of equities held by private noninsured pension plans fell to 54% of net assets, a full 20-point drop from the level deemed appropriate when the Dow was 400 points higher.
By 1976, the courage of pension managers rose in tandem with the price level, and 56% of available funds was committed to stocks. The Dow that year averaged close to 1,000, a level then about 25% above book value.
In 1978, stocks were valued far more reasonably, with the Dow selling below book value most of the time. Yet a new low of 9% of net funds was invested in equities during the year. The first quarter of 1979 continued at very close to the same level. By these actions, pension managers, in record-setting manner, are voting for purchase of bonds--at interest rates of 9% to 10%--and against purchase of American equities at prices aggregating book value or less. But these same pension managers probably would concede that those American equities, in aggregate and over the longer term, would earn about 13% (the average in recent years) on book value. And, overwhelmingly, the managers of their corporate sponsors would agree.
Many corporate managers, in fact, exhibit a bit of schizophrenia regarding equities. They consider their own stocks to be screamingly attractive. But, concomitantly, they stamp approval on pension policies rejecting purchases of common stocks in general. And the boss, while wearing his acquisition hat, will eagerly bid 150% to 200% of book value for businesses typical of corporate America but, wearing his pension hat, will scorn investment in similar companies at book value. Can his own talents be so unique that he is justified both in paying 200 cents on the dollar for a business if he can get his hands on it, and in rejecting it as an unwise pension investment at 100 cents on the dollar if it must be left to be run by his companions at the Business Roundtable?
A simple Pavlovian response may be the major cause of this puzzling behavior. During the last decade, stocks have produced pain--both for corporate sponsors and for the investment managers the sponsors hire. Neither group wishes to return to the scene of the accident. But the pain has not been produced because business has performed badly, but rather because stocks have underperformed business. Such underperformance cannot prevail indefinitely, any more than could the earlier overperformance of stocks versus business that lured pension money into equities at high prices.
Can better results be obtained over, say, 20 years from a group of 9 1/2% bonds of leading American companies maturing in 1999 than from a group of Dow-type equities purchased, in aggregate, at around book value and likely to earn, in aggregate, around 13% on that book value? The probabilities seem exceptionally low. The choice of equities would prove inferior only if either a major sustained decline in return on equity occurs or a ludicrously low valuation of earnings prevails at the end of the 20-year period. Should price/earnings ratios expand over the 20-year period--and that 13% return on equity be averaged--purchases made now at book value will result in better than a 13% annual return. How can bonds at only 9 1/2% be a better buy?
Think for a moment of book value of the Dow as equivalent to par, or the principal value of a bond. And think of the 13% or so expectable average rate of earnings on that book value as a sort of fluctuating coupon on the bond--a portion of which is retained to add to principal amount just like the interest return on U.S. Savings Bonds. Currently our "Dow Bond" can be purchased at a significant discount (at about 840 vs. 940 "principal amount," or book value of the Dow. Figures are based on the old Dow, prior to the recent substitutions. The returns would be moderately higher and the book values somewhat lower if the new Dow had been used.). That Dow Bond purchased at a discount with an average coupon of 13%--even though the coupon will fluctuate with business conditions--seems to me to be a long-term investment far superior to a conventional 9 1/2% 20-year bond purchased at par.
Of course, there is no guarantee that future corporate earnings will average 13%. It may be that some pension managers shun stocks because they expect reported returns on equity to fall sharply in the next decade. However, I don't believe such a view is widespread.
Instead, investment managers usually set forth two major objections to the thought that stocks should now be favored over bonds. Some say earnings currently are overstated, with real earnings after replacement-value depreciation far less than those reported. Thus, they say, real 13% earnings aren't available. But that argument ignores the evidence in such investment areas as life insurance, banking, fire-casualty insurance, finance companies, service businesses, etc.
In those industries, replacement-value accounting would produce results virtually identical with those produced by conventional accounting. And yet, one can put together a very attractive package of large companies in those fields with an expectable return of 13% or better on book value and with a price which, in aggregate, approximates book value. Furthermore, I see no evidence that corporate managers turn their backs on 13% returns in their acquisition decisions because of replacement-value accounting considerations.
A second argument is made that there are just too many question marks about the near future; wouldn't it be better to wait until things clear up a bit? You know the prose: "Maintain buying reserves until current uncertainties are resolved," etc. Before reaching for that crutch, face up to two unpleasant facts: The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.
If anyone can afford to have such a long-term perspective in making investment decisions, it should be pension-fund managers. While corporate managers frequently incur large obligations in order to acquire businesses at premium prices, most pension plans have very minor flow-of-funds problems. If they wish to invest for the long term--as they do in buying those 20- and 30-year bonds they now embrace--they certainly are in a position to do so. They can, and should, buy stocks with the attitude and expectations of an investor entering into a long-term partnership.
Corporate managers who duck responsibility for pension management by making easy, conventional or faddish decisions are making an expensive mistake. Pension assets probably total about one-third of overall industrial net worth and, of course, bulk far larger in the case of many specific industrial corporations. Thus, poor management of those assets frequently equates to poor management of the largest single segment of the business. Soundly achieved higher returns will produce significantly greater earnings for the corporate sponsors and will also enhance the security and prospective payments available to pensioners.
Managers currently opting for lower equity ratios either have a highly negative opinion of future American business results or expect to be nimble enough to dance back into stocks at even lower levels. There may well be some period in the near future when financial markets are demoralized and much better buys are available in equities; that possibility exists at all times. But you can be sure that at such a time the future will seem neither predictable nor pleasant. Those now awaiting a "better time" for equity investing are highly likely to maintain that posture until well into the next bull market.
source: Forbes
Monday, July 5, 2010
Warren Buffett -- in 1974
Under the 1974 headline, "Look At All Those Beautiful, Scantily Clad Girls Out There!," this profile in Forbes magazine captures Warren Buffett's personality and chronicles the singular path he cut through the investment world. Though the piece is 34 years old, it sheds light on the man behind Berkshire Hathaway as the company's shareholders meet this weekend in Omaha, Neb.
Robert Lenzner and Evelyn Rusli will be reporting from Omaha all weekend. You can find the latest on the shareholders' meeting here.
How do you contemplate the current stock market, we asked Warren Buffett, the sage of Omaha, Neb.
"Like an oversexed guy in a harem," he shot back. "This is the time to start investing."
The Dow was below 600 when he said that. Before we could get Buffett's words in print, it was up almost 15% in one of the fastest rallies ever.
We called him back and asked if he found the market as sexy at 660 as he did at 580. "I don't know what the averages are going to do next," he replied, "but there are still plenty of bargains around." He remarked that the situation reminded him of the early '50s.
Warren Buffett doesn't talk much, but when he does it's well worth listening to. His sense of timing has been remarkable. Five years ago, late in 1969, when he was 39, he called it quits on the market. He liquidated his money management pool, Buffett Partnership, Ltd., and gave his clients their money back. Before that, in good years and bad, he had been beating the averages, making the partnership grow at a compounded annual rate of 30% before fees between 1957 and 1969. (That works out to a $10,000 investment growing to $300,000 and change.)
He quit essentially because he found the game no longer worth playing. Multiples on good stocks were sky-high, the go-go boys were "performing" and the list was so picked over that the kind of solid bargains that Buffett likes were not to be had. He told his clients that they might do better in tax-exempt bonds than in playing the market. "When I got started," he says, "the bargains were flowing like the Johnstown flood; by 1969 it was like a leaky toilet in Altoona." Pretty cagey, this Buffett. When all the sharp MBAs were crowding into the investment business, Buffett was quietly walking away.
Buffett settled back to manage the business interests he had acquired, including Diversified Retailing, a chain of women's apparel stores; Blue Chip Stamps, a western states trading stamp operation; and Berkshire Hathaway, a diversified banking and insurance company that owned, among other things, a weekly newspaper, The Omaha Sun. The businesses did well. Under Buffett's management, the Sun won a Pulitzer prize for its exposé of how Boys Town, despite pleas of poverty, had been turned into a "moneymaking machine."
Swing, You Bum!
Buffett is like the legendary guy who sold his stocks in 1928 and went fishing until 1933. That guy probably didn't exist. The stock market is habit-forming: You can always persuade yourself that there are bargains around. Even in 1929. Or in 1970. But Buffett did kick the habit. He did "go fishing" from 1969 to 1974. If he had stuck around, he concedes, he would have had mediocre results.
"I call investing the greatest business in the world," he says, "because you never have to swing." You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it."
But pity the pros at the investment institutions. They're the victims of impossible "performance" measurements. Says Buffett, continuing his baseball imagery, "It's like Babe Ruth at bat with 50,000 fans and the club owner yelling, 'Swing, you bum!' and some guy is trying to pitch him an intentional walk. They know if they don't take a swing at the next pitch, the guy will say, 'Turn in your uniform.'" Buffett claims he set up his partnership to avoid these pressures.
Stay dispassionate and be patient is Buffett's message. "You're dealing with a lot of silly people in the marketplace; it's like a great big casino and everyone else is boozing. If you can stick with Pepsi, you should be OK." First the crowd is boozy on optimism and buying every new issue in sight. The next moment it is boozy on pessimism, buying gold bars and predicting another Great Depression.
Fine, we said, if you're so bullish, what are you buying? His answer: "I don't want to tout my own stocks."
Any general suggestions, we asked?
Just common sense ones. Buy stocks that sell at ridiculously low prices. Low by what standards? By the conventional ones of net worth, book value, the value of the business as a going concern. Above all, stick with what you know; don't get too fancy. "Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management and limited exposure to hard times." No high technology. No multicompanies. "I don't understand them," says Buffett. "Buy into a company because you want to own it, not because you want the stock to go up."
"A water company is pretty simple," he says, adding that Blue Chip Stamps has a 5% interest in the San Jose Water Works. "So is a newspaper. Or a major retailer." He'll even buy a Street favorite if he isn't paying a big premium for things that haven't happened yet. He mentions Polaroid. "At some price, you don't pay anything for the future, and you even discount the present. Then, if Dr. Land has some surprises up his sleeve, you get them for nothing."
Have faith in your own judgment or your adviser's, Buffett advises. Don't be swayed by every opinion you hear and every suggestion you read. Buffett recalls a favorite saying of Professor Benjamin Graham, the father of modern security analysis and Buffett's teacher at Columbia Business School: "You are neither right nor wrong because people agree with you." Another way of saying that wisdom, truth, lies elsewhere than in the moment's moods.
All Alone?
What good, though, is a bargain if the market never recognizes it as a bargain? What if the stock market never comes back? Buffett replies: "When I worked for Graham-Newman, I asked Ben Graham, who then was my boss, about that. He just shrugged and replied that the market always eventually does. He was right--in the short run, it's a voting machine; in the long run, it's a weighing machine. Today on Wall Street they say, 'Yes, it's cheap, but it's not going to go up.' That's silly. People have been successful investors because they've stuck with successful companies. Sooner or later the market mirrors the business." Such classic advice is likely to remain sound in the future when they write musical comedies about the go-go boys.
We reminded Buffett of the old play on the Kipling lines: "If you can keep your head when all about you are losing theirs … maybe they know something you don't."
Buffett responded that, yes, he was well aware that the world is in a mess. "What the DeBeers did with diamonds, the Arabs are doing with oil; the trouble is we need oil more than diamonds." And there is the population explosion, resource scarcity, nuclear proliferation. But, he went on, you can't invest in the anticipation of calamity; gold coins and art collections can't protect you against Doomsday. If the world really is burning up, "you might as well be like Nero and say, 'It's only burning on the south side.'"
"Look, I can't construct a disaster-proof portfolio. But if you're only worried about corporate profits, panic or depression, these things don't bother me at these prices."
Buffett's final word: "Now is the time to invest and get rich."
source: Forbes.com
Robert Lenzner and Evelyn Rusli will be reporting from Omaha all weekend. You can find the latest on the shareholders' meeting here.
How do you contemplate the current stock market, we asked Warren Buffett, the sage of Omaha, Neb.
"Like an oversexed guy in a harem," he shot back. "This is the time to start investing."
The Dow was below 600 when he said that. Before we could get Buffett's words in print, it was up almost 15% in one of the fastest rallies ever.
We called him back and asked if he found the market as sexy at 660 as he did at 580. "I don't know what the averages are going to do next," he replied, "but there are still plenty of bargains around." He remarked that the situation reminded him of the early '50s.
Warren Buffett doesn't talk much, but when he does it's well worth listening to. His sense of timing has been remarkable. Five years ago, late in 1969, when he was 39, he called it quits on the market. He liquidated his money management pool, Buffett Partnership, Ltd., and gave his clients their money back. Before that, in good years and bad, he had been beating the averages, making the partnership grow at a compounded annual rate of 30% before fees between 1957 and 1969. (That works out to a $10,000 investment growing to $300,000 and change.)
He quit essentially because he found the game no longer worth playing. Multiples on good stocks were sky-high, the go-go boys were "performing" and the list was so picked over that the kind of solid bargains that Buffett likes were not to be had. He told his clients that they might do better in tax-exempt bonds than in playing the market. "When I got started," he says, "the bargains were flowing like the Johnstown flood; by 1969 it was like a leaky toilet in Altoona." Pretty cagey, this Buffett. When all the sharp MBAs were crowding into the investment business, Buffett was quietly walking away.
Buffett settled back to manage the business interests he had acquired, including Diversified Retailing, a chain of women's apparel stores; Blue Chip Stamps, a western states trading stamp operation; and Berkshire Hathaway, a diversified banking and insurance company that owned, among other things, a weekly newspaper, The Omaha Sun. The businesses did well. Under Buffett's management, the Sun won a Pulitzer prize for its exposé of how Boys Town, despite pleas of poverty, had been turned into a "moneymaking machine."
Swing, You Bum!
Buffett is like the legendary guy who sold his stocks in 1928 and went fishing until 1933. That guy probably didn't exist. The stock market is habit-forming: You can always persuade yourself that there are bargains around. Even in 1929. Or in 1970. But Buffett did kick the habit. He did "go fishing" from 1969 to 1974. If he had stuck around, he concedes, he would have had mediocre results.
"I call investing the greatest business in the world," he says, "because you never have to swing." You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it."
But pity the pros at the investment institutions. They're the victims of impossible "performance" measurements. Says Buffett, continuing his baseball imagery, "It's like Babe Ruth at bat with 50,000 fans and the club owner yelling, 'Swing, you bum!' and some guy is trying to pitch him an intentional walk. They know if they don't take a swing at the next pitch, the guy will say, 'Turn in your uniform.'" Buffett claims he set up his partnership to avoid these pressures.
Stay dispassionate and be patient is Buffett's message. "You're dealing with a lot of silly people in the marketplace; it's like a great big casino and everyone else is boozing. If you can stick with Pepsi, you should be OK." First the crowd is boozy on optimism and buying every new issue in sight. The next moment it is boozy on pessimism, buying gold bars and predicting another Great Depression.
Fine, we said, if you're so bullish, what are you buying? His answer: "I don't want to tout my own stocks."
Any general suggestions, we asked?
Just common sense ones. Buy stocks that sell at ridiculously low prices. Low by what standards? By the conventional ones of net worth, book value, the value of the business as a going concern. Above all, stick with what you know; don't get too fancy. "Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management and limited exposure to hard times." No high technology. No multicompanies. "I don't understand them," says Buffett. "Buy into a company because you want to own it, not because you want the stock to go up."
"A water company is pretty simple," he says, adding that Blue Chip Stamps has a 5% interest in the San Jose Water Works. "So is a newspaper. Or a major retailer." He'll even buy a Street favorite if he isn't paying a big premium for things that haven't happened yet. He mentions Polaroid. "At some price, you don't pay anything for the future, and you even discount the present. Then, if Dr. Land has some surprises up his sleeve, you get them for nothing."
Have faith in your own judgment or your adviser's, Buffett advises. Don't be swayed by every opinion you hear and every suggestion you read. Buffett recalls a favorite saying of Professor Benjamin Graham, the father of modern security analysis and Buffett's teacher at Columbia Business School: "You are neither right nor wrong because people agree with you." Another way of saying that wisdom, truth, lies elsewhere than in the moment's moods.
All Alone?
What good, though, is a bargain if the market never recognizes it as a bargain? What if the stock market never comes back? Buffett replies: "When I worked for Graham-Newman, I asked Ben Graham, who then was my boss, about that. He just shrugged and replied that the market always eventually does. He was right--in the short run, it's a voting machine; in the long run, it's a weighing machine. Today on Wall Street they say, 'Yes, it's cheap, but it's not going to go up.' That's silly. People have been successful investors because they've stuck with successful companies. Sooner or later the market mirrors the business." Such classic advice is likely to remain sound in the future when they write musical comedies about the go-go boys.
We reminded Buffett of the old play on the Kipling lines: "If you can keep your head when all about you are losing theirs … maybe they know something you don't."
Buffett responded that, yes, he was well aware that the world is in a mess. "What the DeBeers did with diamonds, the Arabs are doing with oil; the trouble is we need oil more than diamonds." And there is the population explosion, resource scarcity, nuclear proliferation. But, he went on, you can't invest in the anticipation of calamity; gold coins and art collections can't protect you against Doomsday. If the world really is burning up, "you might as well be like Nero and say, 'It's only burning on the south side.'"
"Look, I can't construct a disaster-proof portfolio. But if you're only worried about corporate profits, panic or depression, these things don't bother me at these prices."
Buffett's final word: "Now is the time to invest and get rich."
source: Forbes.com
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