Bill Ehrman


We look forward each year for the Saturday morning in February when Warren Buffett, along with Charlie Munger, release their annual shareholder letter. For those who doubt their status as the best investors in our lifetime, just look at their performance over time. The value of Berkshire shares has compounded at 20.3% annually from 1964 – 2019 whereas the S&P 500 with dividends has compounded at 10.0%. And that includes their current cash levels and the float, now exceeding $129 billion. Warren and Charlie are the ultimate investors.

Here are some of our key takeaways from this year’s letter:

  • The intrinsic value of their equity holdings continues to grow steadily and substantially.
  • Retained earnings is like compound interest as it funds future growth with higher and higher profits. Use retained earnings advantageously and seek to invest in your businesses. Berkshire’s depreciation charges have aggregated $65 billion whereas internal investments in property, plant and equipment have totaled $121 billion.
  • The power of compounding and holding long term rather than selling a stock and paying a federal tax of 21% is clear. If you sell a stock that you like longer term but worry about the short term, the stock would have to drop 21% before you can buy it back and break even. Hear us traders!
  • Deploy capital without employing excessive debt levels. Their investments earn more than 20% on net tangible equity capital required to run their businesses. This is mind-blowing when compared to the returns on bonds over the last decade-2.5% or even less on the 30-year Treasury bonds.
  • It is almost certain that equities will outperform bonds over time. Remember the American tailwind!
  • A board should be truly independent with business-savvy directors who are owner-oriented.
  • Berkshire will buy back its stock when Buffett/Munger perceive that it is as selling well beneath intrinsic value. They bought back a record $5 billion in 2019 or approximately 1% of the outstanding stock.

Berkshire will meet their fellow “capitalists” at the May 2 Annual Meeting. Do you think that they support Bernie Sanders?

We always reflect deeply after reading their annual shareholder letter. It reminds us that we need to focus almost entirely on long term investing rather than being influenced by short term events. We continue to get better at looking over the valley rather than reacting to short term events that will pass, such as the coronavirus. In fact, it reinforces our thesis that adversity really creates opportunity for long term investors which we are like Buffett and Munger.

On the other hand, we cannot be fully invested like Berkshire at all times as we do not have an insurance float that backstops us. That backstop affords them added capital to buy when and if there are significant drops in the markets.

We begin with a 12 to 24-month market view which impacts our capital allocation by asset class (stock, bonds, cash), the level of investment in each class, which specific sectors to focus on in each class and finally which specific investments to make after our own independent research. While we tend to maintain a significant core portfolio of long-term investments selling well beneath intrinsic value, there is also a part of our portfolios which we are willing to shift amongst and within asset classes consistent with our market view.

Let’s take a look at what is happening in the markets today.

Uncertainty abounds as no one really knows when the coronavirus will be contained. The longer the problem lasts, risks rise that supply lines will be hurt around the world jeopardizing global growth and pricing/profits even more. Our view remains that the worst of the coronavirus will pass within the next several weeks and then it will take China an additional month or so to get it manufacturing/industrial machine up to speed. The key question to ask is whether the coronavirus will impact China’s future potential which is a driving force behind global growth. Our answer remains a resounding no!

We imagine that Charlie Munger, who has been a long term believer and investor in China, is using this opportunity, no matter how unfortunate it may be for the people of China who have been afflicted by the coronavirus, to add more to his exposure as the gap between current price and long term intrinsic value has only widened. We get it.

While the U.S is clearly best positioned to weather the impact of the coronavirus than most other countries, our bond yields have fallen to all-time lows. That’s right. It is hard to imagine that the 30-year treasury fell beneath 2% on Friday. Can you fathom a 2% 30-year bond when our economy is still chugging along around 2% with inflation running near that level too? We have 4% nominal GNP and a 2% long bond. Wow! How much money must be pouring into this country and how scared investors must be to accept a 2% 30-year treasury. Yes, the dollar is strong, too.

It is easy to understand the weakness in our markets last week. All the machines are kicking in predicting a recession with low bond yields along with flat to inverting yield curves. While we do see a near term slowdown here and abroad, we then expect a reacceleration of growth by the second half of the year once the coronavirus peaks which we still anticipate sometime in the early second quarter. We might add that spreads have not widened, and bank capital/liquidity ratios are at all-time highs. Even the IMF is predicting a global economic rebound later this year.

We remain confident that all of the global monetary bodies will keep the spigots wide open providing far more capital to the system than needed by the real economy. Hence, investors will be forced further out on the risk curve. Would you rather own a great company with sensational management, growing with increasing free cash flow after heavily investing in their businesses, selling beneath intrinsic value, yielding over 2.5% and buying back stock or a 30-year treasury yielding under 2%. What would Buffett and Munger do?

We recognize that we are living through uncertain times. But this too shall pass, and we are confident that all the preconditions for accelerating global growth are present once the coronavirus gets contained. After all, monetary policies are extremely accommodative; fiscal stimulation is expanding almost everywhere; trade deals have been reached reducing global trade tensions; Brexit is nearly resolved; Boeing (NYSE:BA) 737 Max should come back in production by the summer; and Trump is doing all in his power as standing President to get re-elected.

The bottom line is that we have not changed our view that the S&P 500 could hit 3600 this year as interest rates are so low while corporate earnings are exceeding expectations. We expect the global economy to pick up in the second half of the year entering 2021 with a full head of steam. We would use current weakness to build positions in economically sensitive stocks selling at recession valuation while reducing defensive stocks. We would be shortening the maturities of your bond holdings and go flat the dollar at a minimum as we are looking for a peak soon. Also, we would be gradually adding to your industrial commodity position favoring copper while excluding energy.

It’s never too late to invest like Buffett and Munger. We recognize how hard it is to invest in a down market but that is when opportunity is greatest for the true investor willing to look over the valley focusing on long term returns. Who can argue with their success?

Our portfolios continue to emphasize technology, especially the semis; global capital goods and industrials; financials, just like Buffett; housing related retailers; low cost, free cash generating industrial commodity companies; cable with content like Disney (NYSE:DIS), healthcare and finally may special situations selling well beneath intrinsic value with exceptional returns on capital.

Remember to review all the facts; pause, reflect and consider mindset shifts; turn off the pundits/experts who are traders rather than investors like Buffett/Munger; look at your asset mix along with risk controls; do independent research and… Invest Accordingly!

Author: Bill Ehrman

Source: Seeking Alpha: The Oracle(s) Of Omaha Speak

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