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Berkshire Hathaway
Market Timing and Valuation

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By CharlesBroadway
February 20, 2003

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One consistent criticism that I hear of indexing and passive investing is a variation of whether or not the market is at a good opportunity either timewise or valuewise in order to invest.

Some here make the argument that today's market is currently overvalued, so you shouldn't buy any large diversified fund such as an index fund. You must resort to stockpicking. I think this advice is misguided.

The market may or may not be overvalued. Obviously, it carries a P/E that is quite high in relation to historic patterns though it has improved considerably over the past year or two. But I think that trying to predict the performance of the market is doomed to failure. Alan Greenspan would probably have said that the market was overvalued in 96, yet it continued to steam ahead. (And yes, I have read Mr. Buffett's article in Fortune magazine. I tempered my optimism long ago.)

We can also look to Mr. Buffett, and his major stockholdings in KO, Gillette, and the Washington Post. Their respective P/E's according to Yahoo are:

KO- 24.84

G- 25.18

WPO- 31.49

I do not see WEB selling at these levels just as he did not sell when their P/E's were much higher. Yet, if these are not buys at current levels, doesn't this mean they are overvalued? And hasn't he left money on the table by not selling at lofty valuations?

When people make a determination concerning whether a stock is overvalued or undervalued, they are making predictions concerning future earnings. I do not see these predictions being esp. better than the hunches of analysts or the divination of technicians.

It doesn't matter what clock you use. Market timing is market timing. This is why I abandoned value investing. After all was said and done, most of my time was spent hoping that my best picks would reach my price range. They never did. They held their value as the market crashed around them. I didn't know anything more than the rest of the market did.

Another thing that has also bothered me is why WEB never bought a sizable stake in Wal-Mart. Walton had everything going. How could Charlie and WEB have missed this one? The reason is obvious. They liked the business, but never liked the price. Does this mean that Wal-Mart was overvalued?

I think Charlie has been kicking himself over Wal-Mart, which explains his love of Costco. I bet he and WEB have had some arguments over this one. In WEB's defense, there is something to be said for staying with your strategy. Of course, if he had stayed with the cigar butt strategy, Berkshire Hathaway would be a forgotten textile factory today.

I believe that price matters. A lower price in relation to future earnings will yield a higher return. A higher price will yield a lower return. The unknown variables are those future earnings. Knowing what we know today, Wal-Mart and a few other companies were obviously undervalued just ten years ago. But who knew?

The real key to Buffett's success isn't what he does, but what he doesn't do. He doesn't sell even if the P/E's are getting high. Of course, he doesn't buy either. This may bring some safety, but that's how you lose a Wal-Mart.

This brings us back to the value vs. growth argument. The facts indicate that one strategy is not better than the other in terms of returns. I'm hearing a few people talking about how value is beating growth and now holds the edge and will hold it forever and finally leave growth in the dust. But this race never ends with growth leading some laps and value leading others. I expect this to continue. Growth will take the lead again and then value and then growth again. Value investors gloat now just as the growth investors gloated just a few years ago. It's really silly.

I believe you should DCA into the market every year regardless of valuation, technical indicators, or anything else except perhaps a sighting of the Four Horsemen of the Apocalypse or the selection of Harvey Pitt as Fed Chairman. The horror of this approach is that you most assuredly will earn the market's average return over that time whatever that will be. For those who reject indexing, then I suggest you do the same DCA with Berkshire Hathaway. If you're holding out for a lower price, remember when BRK was at 1500, and you were waiting for it to go lower then? Yet, I see many of you doing the same hand wringing now.

I find it amazing how people talk about investing for the long term, but then they focus myopically on minor price swings that in the long term will amount to nothing compared to the lost opportunity. Most of this is simply a striving to be consistent with the precise formula on a spreadsheet, yet ignoring the fact that the largest component of that formula is an unknown and subject to wide fluctuation.

Clearly, every 1% discount you get will yield fabulous rewards over a lifetime of investing. This is why I think costs (fees, commissions, taxes) matter, and this is what makes market timing profitable theoretically. But you can control costs. You can't control the market. By waiting, you could just as easily be forfeiting future returns as much as gaining them. The market can go either way.

DCA averaging ensures that most of your investment dollars will buy more value when the stock (or the market) is at its lowest price while also giving you the confidence of knowing you are not going to be missing out on the upside while you have your hands stuck in your pockets. My reading indicates that being out of the market is riskier than being in it.

CONCLUSION
When I go to the supermarket, I see a lot of people trying to pick the shortest line at the checkout, so they can get out faster. Some people gauge the number of groceries in people's carts. Others try to figure out the skill of the cashier and the bagger. Yet, they forget the oldest maxim that seasoned shoppers know by heart. The other line always moves faster. It's smarter to just pick a line and wait. In the long run, it averages out and will prove superior to hopping from line to line.

I do not know where the market is going. I do not know where the economy is going. I know that higher prices carry higher risks. I also know that by holding cash I am also taking a risk. In theory, I can get higher returns by perfect timing relative to price and value or market momentum. In practice, I doubt I can be successful at this endeavor. This condemns me to being average, yet average so far has been quite above average after costs. As for those waiting to buy Berkshire at the "right price," think back to what the right price was just ten years ago.

CBB

***

Here are some quotations on market timing courtesy of Taylor Larimore on the Vanguard Diehards board at M*:

"It's extremely rare to hear of anyone winning at it (market timing) over a period of years. Indeed, I've never heard of such a genius." Jack Brennan

"I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two." Warren Buffet

"If I have noticed anything over these 60 years on Wall Street, is is that people do not succeed in forecasting that's going to happen to the stock market." Benjamin Graham

"Forget about timing the market, it doesn't work. You'll lose money. Invest for the long haul and then sit back and wait--the market always goes up in the long-run." Paul Farrell, Ph.D

"Market-timing is bunk." Pat Dorsey, Director of M* Fund Analysis.

"There will always be someone predicting disaster and someone predicting great fortune. At one time or another, each will be closer to correct than the other. But it won't matter to you if you understand this and have invested responsibly. You have a long-term plan; stick with it." Peter Lynch

"Everyone wants protection from the bear. But it's best to get it through diversification, not by trying to outsmart the market in a game in which the deck is stacked against the investor." C.V.Sanders, Morningstar

"Transaction costs and taxes kill most active traders. That's why no market-timing letter beats buying an index fund and standing pat." Mark Hulbert

"The market timer's Hall of Fame is an empty room." Jane Bryant Quinn

"Market Timing is a poor substitute for a long-term investment plan." Jonathan Clements

"No, I don't believe in market timing. I've been around this business darn near a half-century, and I know I can't do it successfully.-- In fact, I don't even know anyone who knows anyone who has ever successfully timed the market over the long term." Jack Bogle

"Market timing is an ineffective strategy for mutual Fund Investors." CDA/Wiesenberger

"The only way to make money with a newsletter is by selling one." Malcolm Forbes

"Nobody but nobody, has consistently guessed the direction of the bond or stock market over any meaningful length of time." John Markese President, AAII Journal

"I've learned that market timing can ruin you." Elaine Garzarelli

"Among the 160 or so newsletters the HFD monitors, the market timing recommendations of only 10 have beaten the stock market over the last decade on a risk-adjusted basis." Mark Hulbert 1-18-01

"As you can probably sense, we're not keen on market-timing. It just doesn't work." Morningstar's Course 106

"Over a 12.5 year period, 224 of 237 market timing newsletters went out of business." indexfundsadvisors.com

"I'm a strong advocate of buying and holding." Charles Schwab

"Buy and hold is a very dull strategy. It lacks pizzazz and doesn't inspire much admiration at cocktail parties. It has only one little advantage: It works, very profitably and very consistently." Frank Armstrong

"For most investors the odds favor a buy-and-hold strategy." Carol Gould

"There is absolutely no evidence that anyone can time the market." Bill Bernstein

"Some people in the popular press talk about 'getting into' a bull market and 'getting out of' a bear market, but it is all marketing hype." Rick Ferri

"Only liars manage to always be 'out' during bad times and 'in' during good times." Bernard Baruch

"It must be apparent to intelligent investors who if anyone possessed the ability to do so (market-time) he would become a billionaire so quickly he would not find it necessary to sell his stock market guesses to the general public." David L. Babson

"There is an overwhelming body of evidence to support the view that believing in the ability of market timers is the equivalent of believing astrologers can predict the future." Larry Swedroe

"Don't trade in and out of funds. Stay invested.-- Not only does buy-and-hold investing offer better returns, but it's also less work." Eric Tyson

"Investors should look with a jaundiced eye at any market timing system being peddled by its guru-creator" W. Scott Simon

"Don't waste money subscribing to investment letters or expensive services.--Besides their cost, there is the problem that they are liable to tempt you into buying, and scare you into selling." Andrew Tobias

"If you buy--and then hold--a total-stock-market index fund, it is mathematically certain that you will outperform the vast majority of all other investors in the long run." Jason Zweig

"The facts suggest that successful market timing is extroardinarily difficult to achieve." Burton Malkiel

"If we haven't said it enough, we'll say it again: Market timing is dangerous." Barron's Guide to Making Investment Decisions

"Timing the market is for losers. Time IN the market will get you to the winner's circle, and you'll sleep better at night." Michael Leboeuf


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