The first five-year lag
Much has been made of the reality that, for the first time in its history, Berkshire Hathaway saw its growth in book value trail the S&P 500 over a five-year period.
As a result, many have questioned if Buffett has finally lost it, and others believe Berkshire Hathaway should be cast aside for different compelling investments. Yet, such a plan would be a terrible idea.
During the true market cycle from 2007 to 2013, Berkshire outperformed the S&P 500, and Buffett noted, "through full cycles in future years, we expect to do that again." Yet, Buffett added a critical distinction about what to truly expect from Berkshire Hathaway.
When discussing the results of Berkshire Hathaway, Buffett said:
Charlie Munger, Berkshire's vice chairman and my partner, and I believe both Berkshire's book value and intrinsic value will outperform the S&P in years when the market is down or moderately up.
But this isn't simply some prideful assertion. There have been 15 years in which the S&P 500 has been down or moderately up in Berkshire Hathaway's existence. And as shown in the chart, Berkshire Hathaway has delivered a resounding victory in those years.
The expectations for 2014
With that in mind, it's important to remember that countless people believe 2014 will be a year "when the market is down or moderately up."
FactSet, a research firm, noted in January that market strategists projected the S&P 500 would fall by 2.3% during he next 12 months. Industry analysts weren't quite so bearish, but projected, instead, a 4.8% rise in prices.
Acclaimed investor Seth Klarman -- who manages a hedge fund with $27 billion -- recently said he was "confident that these good times will come to an end," and expected 2014 to be a difficult year.
But simply surveying qualitative expectations and estimations is all too often a terrible idea, and a glance at the quantitative figures reveals an even more staggering reality.
From qualitative to quantitative
One of the reasons many people have been concerned about the market itself is the remarkable rise in relative valuation during the last few years. The acclaimed Shiller P/E Ratio -- the stock price divided by its inflation-adjusted earnings during the past 10 years -- from Nobel laureate Robert Shiller, reveals that stocks are indeed becoming increasingly more expensive relative to historical trends:
In fact, in the 49 years during which Berkshire Hathaway has existed, there have only been 10 years in which the Shiller P/E Ratio was higher than the 25.3 to begin 2014. And the returns in the one year that followed reveals Berkshire Hathaway's book value growth topped the S&P 500 eight of the years by an average of 6%. Not bad.
Yet, The Motley Fool doesn't believe in simply holding onto a company for a year or two -- and certainly neither does Buffett -- and expanding the time horizon to five years after the Shiller P/E has been this high further highlights Berkshire's success.
As you can see, during the 10 times when the market was valued higher than it currently is, Berkshire Hathaway delivered dramatically better returns during a five-year period. On average, Berkshire Hathaway grew its book value by an annual return of 9.4% in the following five years, whereas the S&P 500 has only returned 2.4%.
But that remarkable outpacing isn't exclusive to just a five-year period. When a 10-year period is considered, the results are even more striking:
While the gap is narrowed slightly, Berkshire Hathaway resoundingly beats it, once again. The S&P 500 delivered an average annual return of 3%, and Berkshire saw its book value rise to 9.5%. And although a difference of 6.5% per year may not sound like a lot, the S&P 500, on average, saw a 10-year total return of just 35%, compared to a staggering 150% by Berkshire Hathaway.
Attempting to time the market is a dangerous game, and the numbers shown above shouldn't serve as a deterrent to anyone investing. In the course of a lifetime, placing money every month into the S&P 500 has been a true success story for millions of investors who have been able to retire rich.
However, Buffett has a resoundingly successful history of outperformance in seasons both good and bad, which is one reason why Berkshire Hathaway presents itself as a compelling investment consideration.
The greatest thing Warren Buffett ever said
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Patrick Morris owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.