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Buffett: Stocks Are Cheaper Than Bonds

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In addition to spinning on taxes, Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) CEO Warren Buffett said this week that investors that are buying bonds at current yields are "making a mistake," offering the following advice on asset allocation:

"It's quite clear that stocks are cheaper than bonds," Buffett said. "I can't imagine anyone having bonds in their portfolio when they can own equities, a diversified group of equities."

Although I disagree with the idea of comparing stock and bond valuations, I do agree with Buffett that government bonds are unattractive. At a yield of 2.39% for the 10-year Treasury, the best outcome is that you will earn a 2.39% annual return on your investment. That is stating the obvious, but to paraphrase George Orwell, yield-starved investors have sunk to such depths that restatement of the obvious is the first duty of the intelligent analyst.

Would you accept a half a percent in return?
To get an idea of your expected annual return on an inflation-adjusted basis, just take a glance at the real yield on the same maturity TIPS (Treasury inflation-protected securities), which is now less than half a percent. Faced with that prospect, I'd prefer to keep my money in cash and wait for better opportunities.

High-quality dividend payers are attractive
As for the second half of Buffett's recommendation ("when they can own a diversified group of equities"), I disagree if he is referring to owning the S&P 500 index, but I'm on board if he means high-quality dividend stocks -- one of the most attractive segments in this market. If you are looking for specific names, you need look no further than Berkshire's own portfolio, which contains just such stocks, including:


Dividend Yield

Long-Term EPS Growth

P/E Multiple*

Republic Services (NYSE: RSG  )




ExxonMobil (NYSE: XOM  )




General Electric (NYSE: GE  )




Berkshire Hathaway Stock Portfolio




Benchmark: SPDR S&P 500 ETF (NYSE: SPY  )




Source: Capital IQ, a division of Standard & Poor's, and AlphaClone. Market data as of June 5.

Stocks for the long run
I'll end by stating another home truth: If you're going to put your money into stocks, you must adopt a long time horizon -- as Gluskin Sheff economist David Rosenberg noted this week, "a stock by definition has an infinite duration." Investors who are prepared to do this should find that a well-chosen group of high-quality names should provide a very acceptable return.

At a five-year time horizon, dividend yield and dividend growth account for nearly 80% of stocks' total return. Over the next five years, it could well be higher than that. The Motley Fool's top analysts have identified 13 high-yielding stocks to buy today.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks in this article. Berkshire Hathaway is a Motley Fool Inside Value pick. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Republic Services is a Motley Fool Income Investor pick. The Fool owns shares of Berkshire Hathaway and ExxonMobil. Try any of our Foolish newsletter services free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.

Read/Post Comments (20) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 07, 2010, at 4:55 PM, BillyTG wrote:


  • Report this Comment On October 07, 2010, at 8:24 PM, emptygestures wrote:

    Sometimes I think Buffett is getting too old for this game.

  • Report this Comment On October 07, 2010, at 8:34 PM, tshk1221 wrote:

    The Oracle is always so correct.

    For example,

    MSFT: P/E of 11.68 as of today

    Which translates into a capital yield of 8.56% (1 divided by 11.68 P/E)

    In addition to the capital yield, we get the dividend yield of 2.6% if bought today.

    In addition, you get an inflation yield of approximately 2.5% (MSFT products are 100% inflation protected).

    Therefore, in summary, if you bought MSFT today, you get the following total yield:

    Capital Yield: 8.56%

    Dividend Yield: 2.6%

    Inflation Yield: 2.5% (approx)

    Total Yield: 13.66%

    This total yield of 13.66% will compound as long as MSFT continues to operate as it is as shown in the 3 years' income statement and balance sheet of Yahoo. Besides, its EPS growth rate was about 15% for the last 5 years, supporting the total yield to compound annually.

    I'm getting about 13% Total Yield for my KO I got a year ago. What a pleasant gain I'm getting since I'm just sitting and doing nothing but holding KO!

  • Report this Comment On October 07, 2010, at 8:48 PM, TMFAleph1 wrote:


    Thanks for your comment. There is a good case for investing in MSFT today, but you are overstating it slightly by double counting both the 'inflation yield' and the dividend yield.

    It's improper to add the earnings yield (what you call the 'capital yield') to the dividend yield since dividends are paid out of earnings. It is, however, proper to add the estimated long term EPS growth rate to the dividend yield.

    For MSFT, that comes to:

    10.37% + 2.60% = 12.97%

    As for the 'inflation' yield, any return that accrues simply due to inflation is included in the estimated EPS growth rate.

    Alex D

  • Report this Comment On October 07, 2010, at 8:49 PM, TMFAleph1 wrote:


    It's difficult to know what you mean by this -- Can you expand on your comment?

    Alex D

  • Report this Comment On October 07, 2010, at 9:35 PM, awallejr wrote:

    Personally I agree with your thesis, and it is how I invest. I much prefer holding T and getting a 6% yield off my money, with the expectation that said dividend will probably grow over time, than hold on to say a 10 year Tbill generating, though guaranteed, yield of about 2.4%.

    However, people keep forgetting about the "Aging of America" factor. Normally as one ages, one shifts his asset allocation away from stocks and into bonds. You are seeing that now and I suspect it will continue to do so for many years to come.

    That doesn't mean that is the best approach in the end, but hindsight is always 20-20. People want the guaranteed income. Does them no good when a company, your GE illustration for example, CUTS their dividend.

  • Report this Comment On October 07, 2010, at 10:14 PM, MegaEurope wrote:

    TMFMarathonMan wrote: "Although I disagree with the idea of comparing stock and bond valuations"

    Surely you disagree with certain superficial ways of comparing them, not the idea of comparing them in general?

    If you are philosophically opposed to comparing stocks to bonds, how would you decide how to invest? Flip a coin?

  • Report this Comment On October 07, 2010, at 10:15 PM, TigerPack1 wrote:

    I think Buffett's main point wasn't that stocks are cheap, but that bonds are completely overvalued with the bond bubble about to end.

    Commodity prices have risen 20%-25% (depending on your index) the last 12 months! Investors willing to accept yields of ZERO to 5% on bonds that could collapse in underlying value are nearly brain dead! Given QE 2 from BEN and the idiots at the FED, increasing rates of inflation and a collapsing Dollar value are now assured in the near future. Why would anyone buy an investment that returns nothing, where you are risking everything you invest under the most likely outcomes of depression and HYPERINFLATION?

    The Treasury bond bubble and ponzi debt buying by BEN the last few years, may end up being the most destructive boom of all to America's long-term future. The Tech bubble of the late-1990s and real estate bubble of the mid-2000 decade were small potatoes, in terms of destroying the foundation of free markets and democracy in this once great land.

    Add Buffett's name, to Greenspan, Soros, J. Rogers, and a growing list of academics and economists that are on record saying American capitalism is in permanent decline now.

    Quite sad - we have the best leaders money can buy, that are only considered with the next election cycle and short-term fixes. That's why China has taken U.S. to the cleaners since President Clinton sold out 20 years ago, giving China most favored nation trade status, with no strings attached.

    I guess you reap what you sow, and we haven't planted much of importance since the invention of the internet decades ago.


  • Report this Comment On October 07, 2010, at 10:26 PM, TigerPack1 wrote:

    U.S. Treasury downgrade from top-notch credit rating should have happened in 2009... The fraudulent rating of our ability to repay tens of trillions in debt will soon change, as the base of our economic system, the mighty Dollar's stable value, is being shaken wildly by BEN and the FED now.

    China, Japan, and now Europe will no longer fund our Treasury borrowing needs going forward as all confidence in our leaders and ability to repay debts in constant, inflation-adjusted Dollars collapses. Americans have no savings to buy bonds in significant volumes, and our banking system is close to default under an honest accounting of derivative and real estate losses. [A second larger bailout of banks is coming in early 2011, but I will not get into that here.]

    How are we going to borrow an additional $1-2 trillion in new deficit spending in 2011, and roll-over another $4 trillion in debt coming due next year without paying any interest yield or incentive to attract capital? We cannot without direct money printing and FED ponzi buying. We are ALREADY effectively in default but somehow retain the highest of all credit ratings! Clearly, credit ratings agencies are a sham -political vehicles out to make a buck for themselves at everyone else's expense.

    The bond bubble will soon burst, no one should be surprised at this stage. A credit downgrade or simple market forces will now take over to create a substantial increase in interest rates to bring in the necessary capital to keep government checks from bouncing, or QE 2 will DIRECTLY lead to massive inflation and a spike in interest rates... There are no other honest outcomes at this stage.


  • Report this Comment On October 07, 2010, at 11:12 PM, TMFAleph1 wrote:


    I disagree with the idea of comparing them in general. Stocks and bonds aren't competing assets: They have different risk/ return characteristics and they fulfill different roles within a portfolio.

    As far as deciding how to invest, I don't see why one would need to compare stocks to bonds. Why is preventing you from evaluating each asset class separately on an absolute basis? In this instance, for example, if we admit that high-quality stocks are attractive, it is not because bonds are overvalued: We don't need to have a view on bond valuations to hold the former opinion.

    I hope this clarifies my position.

    Alex D

  • Report this Comment On October 07, 2010, at 11:43 PM, MegaEurope wrote:

    So how do you decide what percent of your portfolio to allocate to stocks and what percent to bonds? Isn't that based on a comparison of their value (explicit or implicit)?

  • Report this Comment On October 07, 2010, at 11:45 PM, tekennedy wrote:

    @TMFMarathonMan-"Stocks and bonds aren't competing assets: They have different risk/ return characteristics and they fulfill different roles within a portfolio."

    Thats a tough statement to make IMO. Of course they do have different risk characteristics but they serve the same purpose of earning a return on investment. Wouldn't it make sense to compare probable longterm returns?

    How about a hypothetical: the stock market goes to a PE of 30 over the next 6 months. Wouldn't you consider selling your stock positions for either debt securities or a rental property or cash or almost anything else due to the low expected return of ~3%? I understand that a 3% yield isn't the same as a 3% treasury but I think it's beneficial comparing the investment characteristics of all available options.

  • Report this Comment On October 08, 2010, at 12:29 AM, TMFAleph1 wrote:

    "So how do you decide what percent of your portfolio to allocate to stocks and what percent to bonds? Isn't that based on a comparison of their value (explicit or implicit)?"

    You can make that decision with regard to the degree of over-/ under-valuation of a specific asset class and its weight in the market portfolio (or whatever benchmark portfolio may be).

    In a situation in which both stocks and bonds are undervalued, you may need to make some sort of comparison of expected risk-adjusted returns to set your 'tilt' (overweighting), but that is clearly not the case here.

    In sum, you are right that it is not an absolute rule.

  • Report this Comment On October 08, 2010, at 12:40 AM, DBrown7 wrote:


    Buffett has never said American capitalism is in permanent decline. In fact he has stated that America's best days are yet to come. When Berkshire acquired Burlington Northern, he said it was his bet on the future of America.

  • Report this Comment On October 08, 2010, at 4:10 AM, daveandrae wrote:

    If one person is investing his money at 7%, and another person is investing his money at 3%, then it should be obvious to you who is getting a better return on this money, over time.

    Right now, the s&p 500 is yielding 7% in forward earnings power ( 82.37/1158 = 7.19%) compared to an interest rate that is less than 3% for a ten year treasury bond. Thus, the index stock buyer is accruing an additional 4% a year over the bond buyer. Over a ten year holding period, an additional 4% a year in earnings power over bond interest offsets all of the vicissitudes of equity investing .

    This is why you do not need a lot of hindsight or foresight for things to work out successfully. As long as the equity buyer is making his purchases at the lower end of the market, and maintaining a long term view of his holdings, then it only stands to reason that he will have done better than the bond buyer over time.

    Thomas Edmonds

  • Report this Comment On October 08, 2010, at 8:13 AM, TigerPack1 wrote:


    Clearly, you read to many press releases!

    Buffett bought BNI because it was the closest thing he could find to a 100% government regulated and guaranteed cash flow machine. The railroad has almost no competition within the oligopoly industry of 1 or 2 competitors where they own track. Plus Burlington will be able to raise prices and profits as inflation takes hold... Railroads are far, far removed from a growth industry. Where else could he invest $20-$30 billion and get a guaranteed 5%-7% annual return on his investment, that has an honest adjustment for inflation and rising costs????

    Otherwise, he has been a large net SELLER of stocks in 2010. If you look at his actions and not his rhetoric, he is investing quite conservatively because he is scared chitless about what is going on in Washington, with an out-of-control debt and trade imbalance situation.

    Read "between" the lines; you are quite capable of thinking for yourself.


  • Report this Comment On October 08, 2010, at 11:03 AM, Gregeph wrote:

    If you want to monitor the relationship between the yield on stocks and bonds I track the following data on my blog: 1) S&P 500 Yield vs. 10 Year AA Corporate Bond Yield, 2) S&P 500 Yield vs. 10 Year U.S. Treasury, 3) Total U.S. Market Cap / U.S. GDP (Buffett’s favorite market valuation metric.)

  • Report this Comment On October 08, 2010, at 12:36 PM, douglee8 wrote:

    It is not true that the best outcome for a treasury bond investment is its current yield. An investor can sell a bond after its yield has dropped, resulting in a capital gain.

  • Report this Comment On October 15, 2010, at 1:50 PM, 3p wrote:

    It would be nice if Bershire began paying a dividend or at least buy back stock

  • Report this Comment On October 15, 2010, at 5:40 PM, dyadco wrote:

    Perhaps we are lucky here in Australia.

    Term deposit rates are around 6.5% for 3 years, although you can get higher, and Government Bonds offer around 6%.

    Now, these are GOVERNMENT GUARANTEED, yes, even Bank Term deposits, (sorry to highlight, but it does give it weight!!) and admittedly, a return like this is hard to ignore as it is locked in.

    Equities here vary from 0% dividend up to say 5% for our banks (not bad, and rated as the safest on the planet) and much higher for REIT's.

    Mmm, perhaps here we are spoilt for choice. However, as a mid 50 yo, I believe in diversification, so I have spread 70/30 in favour of equities and will slowly move the percentage more into Bonds and term deposits over the next 10 years.

    So it may be ok if you are a billionaire to keep everything in equities, but as your average person saving for retirement, diversification is a safer bet.

    And "yes", overseas investors can buy bonds/term deposits in Australia.

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