Berkshire on Bubbles

Too many investors hope momentum will pace them to market-beating returns, piling into the latest hot investments long after it was prudent to do so. And when that happens within any asset class, we've got a bubble on our hands.

Bubbles were a popular topic at the recent Berkshire Hathaway shareholders meeting, where Warren Buffett and Charlie Munger entertained questions ranging from specific company events to thoughts on the Social Security program. Buffett and Munger -- two investing sages -- gladly offered their thoughts on the bubbles of today.

The commodity bubble
Q. Do you think that we are in a commodity bubble?

A. Not in agricultural products, but yes in metals, oils -- the most extreme being in copper.Any asset class that has a big move driven by fundamentals eventually attracts speculators. Once price history takes over it creates envious neighbors. Speculators are like Cinderella at the ball having a great time, but at midnight everything turns to pumpkins and mice. As midnight approaches the party gets to be more fun, and everyone thinks they'll get out before midnight. The problem for Cinderella is that there are no clocks on the wall.

Buffett's concerns were recently echoed by Legg Mason's Bill Miller, who said, "Today people want commodities, emerging market, non-U.S. assets, and small- and mid-cap stocks. Those were all cheap five years ago, and had you bought them then, you would be sitting on enormous gains . [But] [g]iven the choice of buying Commodities with a capital C, or buying capital C -- Citigroup (NYSE: C  ) -- at current prices, I'll take the latter."

The real estate bubble
Q. What are your thoughts on the retail real estate market, specifically California?

A. Where you'll see the biggest fall-off is where people have overbought and engaged in rank speculation. When you have investment-type holdings, the day traders of the Internet move into day trading of condos -- then you can get a market that can move in a big way. Real estate is different from stocks as you only need one buyer who hasn't gotten the word, and you'll make your sale.

I was in California last week and had firsthand signals that the real estate market was in a bubble about to burst; my cab driver was a part-time Realtor and studying for his broker's license; the conference next door to us was "How to Create Wealth from Foreclosures."

What's not hot
As investors, it is important that we remain unemotional and not follow the madness of the crowd. It doesn't matter if the investment is commodities, real estate, or stocks. Following a Paris Hilton-like "That's hot" attitude when making investments will almost always end in disappointment. History is littered with extraordinary bubbles from which we can learn that lesson -- from Holland's 17th-century tulip bubble to our own great tech bubble of the late 1990s. Yet many investors seem destined to repeat the mistakes of history.

Today, it seems only a handful of value investors are interested in U.S. large-cap stocks, despite the fact that share prices of many of them have hardly moved while earnings have just kept rising:

Company

2001 Average P/E

Current P/E

Price May 11, 2001

Price May 12, 2006

Dell (Nasdaq: DELL  )

38.8

16.5

$24.48

$24.02

General Electric (NYSE: GE  )

33.3

19.3

$49.01

$34.28

Citigroup

18.4

10.1

$49.26

$48.99

Wal-Mart (NYSE: WMT  )

36.9

17.3

$54.10

$46.54

Merck (NYSE: MRK  )

24.2

16.3

$37.97

$34.31



These companies produce gobs of cash and consistently high returns on investment. They all source their products globally and have a considerable percentage of sales outside the United States, and are thus less dependent on the probability of a decline in U.S. currency.

The Foolish bottom line
Like most value investors, I'm agnostic as to where I look for value. And while it's often true that we have to go sorting some of the market's most complicated and underfollowed companies in order to find value, today it's some of the world's greatest businesses that can be had on the cheap. That's a fact none of us should ignore.

The table above lists just five examples, which are not necessarily the cheapest large caps, and there are many more that exhibit similar historical price and fundamental characteristics. Moreover, they may even get cheaper. Or you may have to wait two or three years for their true values to be realized by the market.

That said, patient investors can earn great returns buying stocks at discount rather than chasing the hottest asset classes. If you'd like to learn more, kick the Inside Value tires and be my guest free for 30 days.

Philip Durellis the advisor/lead analyst ofMotley Fool Inside Value. He owns shares of Berkshire Hathaway and Dell. Wal-Mart and Dell are Inside Value recommendations. Dell is also a Stock Advisor recommendation. Merck is an Income Investor recommendation. The Fool has a disclosure policy.


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