This Is Why Buffett's Buying Stocks

You think you've had a bad year? Poor Warren Buffett saw more than $16 billion evaporate from his net worth as Berkshire Hathaway followed the market's swoon.

Adding insult to injury, he's been criticized for the awful performance of recent investments in Goldman Sachs and General Electric. 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 penned an op-ed in The New York Times last fall saying he was buying U.S. stocks for his personal portfolio. Since then, markets have done absolutely nothing good and the economy has fallen off a cliff.

This raises the question: Has the Oracle of Omaha lost his touch? 

Seriously?
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 Hewlett-Packard (NYSE: HPQ  ) and IBM (NYSE: IBM  )  -- and even bland companies like General Motors (NYSE: GM  ) and AT&T -- traded like runaway growth was here for good. Since then we've seen not one, but two bubbles burst. The awfulness of our most recent trailing 10-year returns 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

1998-2008

(9%)

1988-1998

331%

1978-1988

165%

1968-1978

(19%)

1958-1968

77%

1948-1958

226%

1938-1948

14%

1928-1938

(49%)

1918-1928

254%

1908-1918

60%

After booms come busts; after busts come booms. That's how markets work. If we had chosen a different 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 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 hacking away, 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 adequate post-inflation returns over the long haul, cash isn't going to get you there. Never has. Never will.

Not only that, but as fear, panic, and forced liquidation rules the market, companies with a history of proven long-term returns -- like Alcoa (NYSE: AA  ) , Eli Lilly (NYSE: LLY  ) , and Dow Chemical (NYSE: DOW  ) -- have recently touched their lowest prices in well over a decade. Anyone who thinks holding cash or buying Treasuries at historic highs in lieu of stocks at historic lows is making a mistake they'll almost certainly regret down the road.

None of this is to say we've reached a market bottom. Historical earnings multiples, for example, suggest that more pain could be in store for investors. Some periods of market lethargy have indeed lasted for longer than 10 years, too.

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.

This article was originally published on Nov. 24, 2008. It has been updated.

Fool contributor Morgan Housel owns shares in Berkshire Hathaway. Berkshire Hathaway is both a Motley Fool Inside Value and Stock Advisor pick. The Fool owns shares of Berkshire Hathaway, and has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (65)

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 January 31, 2009, at 10:50 AM, oldgoldbug wrote:

    In the article, the author mentions discounting the return on T-bills by the 27% inflation has risen during the period under examination, implying a break even performance after inflation. In that case, the $7500 value of stocks should also be discounted, giving a 1998 dollar value after inflation of approximately $5475, or a real loss of $4525.

  • Report this Comment On January 31, 2009, at 2:17 PM, Rasbold wrote:

    Yes, now is the time to be brave. People are clowning Warren Buffet for a short loss? Give me a break. That man will go down in history as the most sucessful investor of all time, even if he dies broke, which he won't. The man is not a fool. For myself, I have invested heavier in the last two months than my entire life. Warren needs great investors to take his place, will you be one of them?

    Buy and Hold, re invest any gains, you will make more in the next ten years than you can imagine!

    If you are in your 60's or older, damn, I am sorry. But for the rest of us, lay that money down, check out my site:

    http:www.whatwouldwarrendo.com

    ...and may your Dow never Jones!

  • Report this Comment On January 31, 2009, at 3:11 PM, noblepaladin wrote:

    Buffett did not lose any money on GS and GE investments. Preferred shares paying 10% is pretty good. The common went down, not Buffett's preferred. Those 5 year call options (warrants) are worth quite a bit of money, even though they are out of the money right now. It is a spectacular play on the inflation/deflation question. If hyperinflation happens, those call options will be worth a lot of money. If deflation continues like it is right now 10% is really good.

  • Report this Comment On January 31, 2009, at 6:39 PM, justthefacts123 wrote:

    I don't know when Buffett said "cash is trash" but I do know that in 1998 he said that stocks were grossly overvalued. In 2008 he said that stocks have become cheap. Certainly he was right in 1998, and (given 10 years of negative returns) I think he is right today. This doesn't mean that we've seen the bottom on the Dow, but (speaking for myself, here) I doubt that there is more than 10% downside left; and probably much less than that.

    Frankly, Maierhofer is entitled to his opinion, and -- who knows -- he might be right. But this feels a lot more like 1981 than 2000 to me.

  • Report this Comment On February 02, 2009, at 9:40 AM, Muhammad4M wrote:

    Sounds like lots of predictions-almost like technical anlysis!

    Seems like the U.S market is being focussed on mainly as well with an emphasis on Buffetts actions.

    No investor can predict the current market-short or long term-not Buffett,Soros or any person.

    Even Berkshire could go bust in this environment.

    Buy and hope is all well and good and works in a certain environment or could fail spectacularly (Japan-trades at 25% of its peak 20 years ago-bet those investors are screaming the "buy and hope" mantra!)

  • Report this Comment On February 05, 2009, at 11:49 PM, SwampBull wrote:

    I like the article. Glad to see others paying attention to the lessons of history, and not getting swept up in the panic.

  • Report this Comment On March 02, 2009, at 7:22 PM, elmuza wrote:

    I am buying an inflation hedge in BRK.A at near book value of $75K....sure we will lose some short-term

    but do you really believe Coke Amex GS GE as well as

    BRK's operating companies will not grow significantly

    by 2015.....time to be greedy...

    elmuza/dad

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