This Is Why Buffett's Buying Stocks

You think you've had a bad year? Poor Warren Buffett has seen more than $16 billion evaporate from his net worth as Berkshire Hathaway  (NYSE: BRK-B  )  followed the market's swoon.

Adding insult to injury, he's been criticized for the awful performance of recent investments in Goldman Sachs (NYSE: GS  )  and General Electric  (NYSE: GE  ) . In addition to preferred shares that pay 10% dividends, he got warrants for common shares at what seemed like great prices -- prices that are waaayy higher than where the stocks are currently trading.

In response to the market panic, Buffett recently penned an op-ed in The New York Times saying he was buying U.S. stocks for his personal portfolio. Since then, markets have done absolutely nothing good, and many sectors have been drowning in red ink.

Has the Oracle of Omaha lost his touch? 

Simon Maierhofer thinks so. In fact, he took issue with Buffett's claim that stocks will outperform cash in the coming years:

How did [Buffett's] "cash is trash" philosophy fare over the past 10 years? $10,000 invested in the S&P 500 exactly 10 years ago would be worth $7,500 today. The safest cash equivalent, [Treasury bills] ... would have returned about 30%, putting you at $13,000. We don't encourage investing by looking in the rear view mirror but a look at the numbers shows that the only bull market right now is in cash.

Let's leave aside for a moment the question of inflation, which ensures that the $10,000 of 10 years ago is not, in fact, the equivalent of $10,000 today. What does the market's performance over the past 10 years suggest for the future?

Up, up, and away
Any 10-year retrospective has to contend with the fact that 1998 was smack in the middle of the dot-com boom, when tech companies like Oracle (Nasdaq: ORCL  ) and Cisco Systems (Nasdaq: CSCO  ) -- and even stalwarts like Home Depot (NYSE:  HD  )  and Tyco (NYSE: TYC  ) -- traded like infinite growth was engraved in the stock price. Since then we've seen not one, but two bubbles burst. The fact that trailing 10-year returns are pretty bad is hardly news. 

But if we look at 10-year returns for the Dow Jones Industrial Average over the past 100 years, a pattern emerges:

10-Year Period

Dow Jones Industrial Average Return





















After booms come busts, after busts come booms. That's how markets work. If we had chosen a different time frame (i.e., ending in 2006 instead of 2008), the numbers would likely be different, but the overall pattern would be the same.

This isn't a short-term, cherry-picked set of data, after all. It's 100 years of market returns, during which time the nation overcame two world wars, four smaller wars, a flu epidemic, the Great Depression, civil uprisings, multiple recessions, oil shocks, and terrorist attacks -- not to mention sideburns, Chia Pets, Carrot Top, and boy bands.

Anything can happen in the short term -- and the short term right now is volatile and unpredictable, as it always is. Over the long term -- going back an entire century -- the trend of the stock market is pretty clear.

But the author doesn't just claim that the past 10 years have been rough for investors -- he claims that this proves investors should be in cash going forward. The problem is, that 30% return he cites in T-bills doesn't account for the 27% compound inflation over the past 10 years, which leaves cash roughly holding even -- and that's largely true across time periods. And if you hold cash as actual cash, well, inflation just keeps taking its bites out, leaving you with less than you started with.

It's time to be brave
Yes, stocks are volatile, especially now. Yes, there will be boom times and bust times -- and the busts are no fun, even when we're resigned to their presence. But if you want your money to earn you positive post-inflation returns over the long term, cash isn't going to get you there.

Not only that, but the very best time to invest in the stock market is when everyone else is panicking -- because you can buy excellent companies at bargain prices. None of this is to say we've reached a market bottom just yet. Historical earnings multiples, for example, suggest that more pain could be in store for investors, and some periods of market lethargy have indeed lasted for longer than 10 years.

Nonetheless, the trend is as true today as it's been for the past century: We're at a point where bargain-hunting investors can be as assured as they've been in decades that stocks will perform well in the long term.

Our team at Motley Fool Inside Value is sifting through the rubble in search of the bargains that will translate into long-term opportunities. To see what they're recommending right now, click here to try the service free for 30 days. There's no obligation to subscribe.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Tyco International, Home Depot, and Berkshire Hathaway are Motley Fool Inside Value selections. Berkshire Hathaway is also a Motley Fool Stock Advisor pick and a Fool holding. The Motley Fool is investors writing for investors.

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  • Report this Comment On December 31, 2008, at 4:22 AM, dividendgrowth wrote:

    If you pay close attention to BRK's 13F-HR, you will find out that Buffett hardly bought any common stocks this year except a few billion ConocoPhilips.

    What he has been focused on was those sweet heart convertible deals that are off limits to small retails like you.

  • Report this Comment On December 31, 2008, at 8:32 AM, davidjon13 wrote:
  • Report this Comment On December 31, 2008, at 9:54 AM, davidjon13 wrote:

    "What does the market's performance over the past 10 years suggest for the future?"

    Absolutely nothing. There's not the slightest reason to think that the economic history of the next ten years will be anything like the economic history of the last ten years. There's not even the slightest reason to think the opposite. There are no data and no reasonable assumptions to extrapolate from the last 10 years to the next 10.

    The fact that we have no idea in what ways they will differ - since we have no information about economic changes in the future - is not sufficient reason to assume that they will be similar. And so...

    "Wovon man nicht sprechen kann, darüber muss man schweigen."

  • Report this Comment On December 31, 2008, at 12:42 PM, TLassen wrote:

    amen to you davidjon13

    couldn't agree with you more. There is no way that statistical or historical data can be used for predicting future performance, it's a complete fallacy.

    But I do agree with the authors comments that markets move in cycles and that 'busts' will be followed by 'booms', which incidentally only gives more validity to the 'buy and hold' strategy.

    Happy New Year to all MF's (Motley Fools!)

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