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Berkshire Hathaway
Value Investing Vs. Trading

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By rclosch
January 27, 2004

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While I consider Warren "Almost insanely Honest", some things are said to make a point, and are not meant to be taken as inflexible rules. I think when he says things like "My favorite Holding period is forever" and "Money managers should be issued a card with twenty punches" He says it because he honestly feels that most investors trade too much, own too many stocks, and buy stocks for the wrong reasons.

Of course he is correct, and by publicly making these statements which are eventually quoted over and over in the financial media, he is doing a positive service for the investing public.

For the people on this board that are Buying Berkshire to hold for ten or fifteen years I have no problem with this. If you do this you will probably get a return that approximates Berkshire's growth in Book Value over that period. And I have no question that this number will beat the over all market. If this is your goal I support your decision, because it is probably the best course for most casual investors.

On the other hand I also agree with posters like Delilama and Madcapitalist Who feel that they can get a better return on their own by following Buffett's example. To do this, I think investing should be approached as a full time occupation, by people with the right temperament, and that most individual investors are better served by the "buy-hold" prior approach. What Buffett has done is What Buffett can do, but you don't necessarily what to try this at home.

What Buffett has Done

If you Set up a spreadsheet of the positions that are Listed in the Berkshire annual reports from 1977 to 1985 you find that buy hold is the exception. Only two stocks (Washington Post & GEICO) were carried thought out the period. Stocks were added or sold almost every year, and seldom was a position held more than two or three years.

Some people have suggested that Warren's Philosophy has changed and he not longer follows this pattern. If you read the chairman's letter this view is reinforced by the itemized stock positions. They give the impression of very little change. But if you look bellow the surface to study the positions that are not itemized in the Chairman's Letter, you get a different picture

There are 35-40 different stocks that show up on the 13F's and they come and go on a regular basis. In the last Two Years there have been 80 some changes in these Quarterly positions. For an Example see " FDC selling and buying Back."

Granted, some of these changes were initiated by Lou Simpson. But Warren is the boss and if Lou was not following a philosophy approved by Warren he would not be there.

My argument is that the Positions listed by name in the Annual Report are basically those that are too big to be sold. That, Warren has decided that they can not be sold because of potential damage to the market for the stock with the announcement of a Berkshire sale, and the punishment inflicted by the Capital gains tax.

I wonder; if Coke were a $600 Million position, how many think it would it still be here?

Trading vs. Value investing

On the surface Value Investing can look a lot like trading, but there is a subtle but very important distinction. "We like to put the emphasis on Price." Warren Says.
Where as, a trader is tying to time the market and guess at market tops and bottoms the value investor is only interested in the price of the individual stock, and is trying to buy with a margin of safety and sell when the stock reaches full value.

Value investing is a very different intellectual process because it does not depend on trying to predict the movement of the stock market, but focuses on the value of the individual business.

To the casual observer it may be hard to tell the difference, because the value investor is likely to buy when the market is down and sell when it is going up. My personal experience has been that my market timing has been much better as a value investor than it was when I was trying to buy at market bottoms and sell at the tops. I find that you are likely to improve your market timing if you are trading strictly on value.

"Sit on your Ass investing"

Charlie's Favorite investment style is always valid but sometimes it works a lot better than others. From 1982 to 2000 it was easy to find one-decision stocks, but from 1966 to 1982 it was quite a different story. More to the point, what about the next ten years? Is buy-hold an investing style well suited to present markets?

Put another way, the Question is: If we want to outperform the market in next ten years, is it best to just buy and hold, or do we need a more aggressive plan? My guess is that what has worked for the last ten years will not work for the next ten years (duh).

I do not see that we are on the threshold of new long-term bull market. While the recent bear market may have ended. Many of the underlying structural problems that gave birth to our bubbles remain, and that could force Allen to slam on the brakes again about the time the market is able to work up a good head of steam.

There is still a huge concentration of capital in the hands of Mutual Funds and Hedge Funds. The existence of these large concentrated pools of capital means that most good quality large cap stocks are still overvalued. These are not conditions that favor the "Sit on your Ass" investor.

Most of all, there is simply a lot more capital sloshing around than there is good investment opportunities. Sooner or later, this going to lead to bad behavior by Mr. Market.

Fat Years � Lean Years

In his 1999 Fortune article Warren divided the recent market history into 17 lean and 17 Fat years. It describes the period from 1965 to 1982 as a period of flat returns because in summer of 1982 the Dow was at about the same palace that was in summer of 1966. While this description is accurate it does not gives us any idea what it was like to own stocks during that period while the Dow ended the period about were it begin it. The ride was anything but flat. It consisted of a Series of four brutal bear markets brought on by Fed tightening to fight inflation. These bear markets were separated by weak bull rallies that lasted one to two years but petered out as stocks reached their old highs.

Warren and Charlie warn that we should expect returns averaging 6% or 7% over the next ten years. But does that mean 6% percent per year every year, or plus 26% this year and Minus 20% next year.

It seems likely to me that the next ten years will be more like the seventies than the nineties. This does not mean that buy-hold will not work, but it probably will not work as well as in did in the eighties and nineties.


Buffett's results 1966-1982

So what was Warren doing during 1970s? Despite a market that was playing roller coaster Berkshire was mostly going up. You can check this by reading the per share book value chart that precedes the Chairman's Letter in the annual report. From 1966 through 1982 a period in which The S&P went nowhere, Berkshire's book value increased by an average of 23% per year (Buffett won the 17-year period over the S&P 391% to zip). The most remarkable thing is there were no down years for Berkshire during the entire 17 years while the S&P had six.

My guess is Warren did not accomplish this by "sitting on his ass". We do not have a good trail of Buffett's behavior during this period because the chairman's letters are only available since 1977, but if we look at what is available in the Letters from 1977 -1985 we see behavior very much in the traditional Value investor - Ben Graham pattern. Buying stocks when they are undervalued and selling them when they approach full value. Rarely were positions held more than a year or two.

Alternatives

I do not feel that the argument there is a lack of attractive investment alternatives is adequate justification for holding on to Berkshire even if we were to face obvious over valuation. As the Market moves further into Bubble II I think it is important to accumulate some cash. The third Quarter report shows 26.7 billion sitting in Omaha earning less than1%. For me that is both a powerful statement about Stock Valuations, and current long-term interest rates: and ample reason to start to build up my pile of Elephant Bullets.


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