Today, at the 2018 Berkshire Hathaway Annual Meeting, Warren Buffett and his partner, Charlie Munger, shared their continuing faith in the U.S. stock market, as well as reasons for pessimism on other assets such as crypto-currencies, bonds and gold. They discussed how their investment strategy has evolved. They are now happy owning more capital intensive businesses, such as railroads and utilities. In a more colorful moment, Munger described trading crypto-currencies as, “trading turds”.
Faith In Owning Productive Assets
Buffett opened the meeting by using a historical example to stress his belief in the long-term benefit of owning stocks. He shared a series of historic, and bleak, New York Times headlines from 1942. At that point, many believed that Japan would continue to invade South-East Asian countries relatively unimpeded, perhaps reaching Australia, leading to potential dire consequences for the United States. Of course, that didn’t come to pass, the direction of the war turned, and stocks were a good investment at that time.
March 1942 was when Buffett made his first stock investment at age 11. His point was not that 1942 was an especially good time to invest, but that long-term investment in U.S. stocks has historically been a great strategy for investors. In fact, a $10,000 investment made then would be worth $51 today. That record is hard for other investments to beat. For example, Buffett stressed that 300 ounces of gold bought in 1942, would still be 300 ounces of gold today.
On the other hand, a successful stock investment can generate profits that can be reinvested. So whereas a company may have had a single factory or brand in 1942, now they may have many many more, whereas 300 ounces gold would still be 300 ounces of gold. He believes that gold owned since the time of Christ has returned far less than 1% a year over a long period of time.
He is also negative on crypto-currencies following broadly similar logic. Ultimately, in Buffett’s view, the way to make money in a non-productive asset, is to sell it for someone else for more than you paid for it, which can be risky and hard to predict. Yet, with productive assets, such as a farm, you can hold the asset and make money. Charlie Munger was more negative on crypto investing, he described the situation as, “somebody else is trading turds, and you decide you can’t be left out”.
Buffett also reminded the audience that GDP per person has increased six-fold over his lifetime. Warren Buffett has lived under 14 different Presidents including the Cuban missile crisis and “war in the streets” in the 1960s as well as a Presidential assassination and a resignation. He’s amazed at the gains the U.S. has made over time and strongly believes the U.S. “really, really works”.
Of course, in 1942 owning the overall market was hard to implement for the smaller investor, and involved significant costs in trading commissions and fees. Today’s many low cost ETFs are able to track the broad U.S. stock market at some of the lowest costs in history. For example, the iShares Core S&P Total U.S. Stock Market ETF currently costs 0.03% a year, or $3 for every $10,000 invested.
Valuations Appear High
Though not talking to it directly, both Buffett and Munger did allude to high valuations currently. Buffett talked about how private market prices for acquisitions are generally high. In the context of currently low bond yields, Munger mentioned how low bond yields have pushed up asset prices, especially for levered buy-outs. Ultimately, though Buffett’s theme is long-term investing, rather than trying to call any particular market cycle. He mentioned that his father-in-law had always found a reason to be pessimistic over recent decades, yet stock investments have continued to rise in value.
Incentives And Moats
Buffett continues to believe in strong management, with the right incentives, and business with moats. Ultimately, they want to buy better companies rather than cheap companies. For example, when questioned about Wells Fargo, a large holding that has experienced penalties for its conduct recently, he chalks a lot of those problems as being the result of the wrong incentives for employees. He mentioned that when managing Berkshire he knew that a few employees would inevitably made mistakes, but the key thing was to make sure that employees weren’t incentivized to do bad things.
Equally, when asked about his investment in Duracell, he praised the companies brand as being a critical asset to the business. He also talked about his experiences buying American Express and GEICO in the past, at times when they were temporarily troubled. Charlie Munger discussed buying Costco at 13x to 14x earnings, and how it made sense based on how the business is managed and its property assets, and that he didn’t run any specific model or formula to inform the purchase. Buffett added how Costco “surprise and delight their customers”. Buffett also discussed Apple, which Berkshire owns around 5% of, where he described the value as a wonderful, special product backed by a very broad ecosystem.
Capital Intensity
Buffet also looks for business that required limited capital whether See’s Candy, American Express or Coca-Cola, which are all long-term Berkshire holdings. However, he mentioned that he now has invested in more capital intensive businesses such as railroads, airlines and utilities, because they now have far more money to put to work and the returns are attractive.
He described these capital intensive business as “second best” and Munger called them “good enough”. At various points during the meeting Buffett mentioned that its much easier to find opportunities for a billion dollars than tens or hundreds of billions of dollars. Having to manage a much greater sum of money, has necessarily changed his investment approach over time. Berkshire are also looking to keep their holdings of public companies below 10%, which further compounds their issues as a very large investor.
Buffett also reminded the audience that he wanted to see his investments decline in value, so that he could buy more of them for the long-term.
The Danger Of Excessive Forecasting
On many topics, despite their incredible success, both Buffett and Munger were quick to emphasis the limits of their expertise. There are some broad themes that remain central to their thinking such as that the U.S. and China are likely to be the dominant global superpowers for the coming decades. Both firmly believe that stocks are likely to be a great way to invest, as people will have a better standard of living 10, 20 or 50 years from now. However, in each case Buffett was hesitant to make specific short-term predictions in keeping with his philosophy.
For example, he felt that the evolution of cybersecurity was very early, and that we would learn a lot about techniques and risks in the coming years. When discussing the bond markets, Buffett mentioned that the trillions of dollar invested in bonds made it hard to forecast the bond markets day-to-day. Equally, Buffett noted that there are many uncertainties impacting his investments in future, whether in payments or the automotive sector, but that these were not necessarily forecastable. In economics, he also mentioned how hard it was to forecast single variable, such as measuring the impact of tax cuts for shareholders. Similarly, he predicts that crypto-currencies will come to a “bad ending” but can’t predict when.
Negative On Bonds
Buffett is negative on bonds in the current market environment. He does hold some short-term bonds as a means of parking cash, which he hopes to put to use in future with new investments, but was extremely sceptical of the attractiveness of long-term bonds. His logic is that the Federal Reserve is targeting an inflation rate of 2% and the 10 Year Treasury yields 3%, therefore, after tax, most investors are going to earn an after tax return of 0.5% or so on longer term bonds. He says this as he believes that the Federal Reserve has the resources and ability to hit its long-term targets. He also believes that neither he nor anyone else, even those at the Federal Reserve, has the ability to precisely forecast events in the bond market over the shorter term, but for the long-term he would far rather invest in stocks than bonds. Buffett mentioned that he did see attractive opportunities in bonds back in the 1980s when interest rates were very high, but hasn’t seen much in terms of opportunities in the bond market since that time.
