Buffett: Eternal Optimist and Ultimate Investor

 

The investment community looks forward each year to reading Warren Buffett’s annual letter to Berkshire Hathaway shareholders hoping to gain insight into his current view of the economy, politics, investing and anything else that he deems relevant in order to be a successful investor today. No one in our lifetime has been more successful at investing than Charlie Munger and him. What fascinates us most is their ability to stick to their core principles/disciplines both in life and investing.

Some of those core principles/disciplines highlighted in their current letter include:

  • “Deploy capital to buy well managed businesses, in whole or part, that possess favorable and durable economic characteristics.”
  • “Many stocks have offered far more for our money than we could obtain by purchasing businesses in their entirety.” Berkshire bought an additional net $25 billion in marketable securities in 2018. (We were surprised that Berkshire did not step up buying significantly when the market swooned in the fourth quarter).
  • Look at net earnings after all deductions when valuing companies, not EBIDTA which excludes “all too real costs.”
  • “Corporate buybacks utilizing excess retained earnings is good for remaining investors as long as the investee stock is underpriced”
  • “Berkshire will forever remain a financial fortress.” U.S. Treasury bill holdings exceeded $112 billion at year end 2018.
  • Berkshire will add to marketable securities in 2019 as the cost to buy total businesses due to needed premiums are too high.
  • The intrinsic value of Berkshire exceeds the current market price so buybacks are likely to accelerate moving forward. (We were disappointed that buybacks shrunk to only $413 million in the fourth quarter down from a rate twice as high in earlier quarters)
  • Focus on long-term results and building value. It is better to retain earnings and invest them rather than paying them out in dividends.
  • The insurance float is the hidden key to Berkshire’s excess liquidity and low financing costs. Deferred income tax is another source of low cost financing.
  • Berkshire’s stock holdings “earn about 20% on the net tangible equity capital required to run the businesses…without employing excessive debt levels.” Compare those returns to long-term bonds yielding around 3% over the last decade. Stocks are a far greater value than bonds.
  • Investing in America has been and will remain successful…. “The American Tailwind.” Berkshire sees great opportunities abroad too and will add to their foreign investments in the years ahead.

We were somewhat surprised and disappointed that Buffett made really no mention of the current environment in any way. We expected some comment on the economy as he has done in the past, but clearly it would have been favorable as witnessed by the across the board strength in Berkshire’s operating businesses for the fourth quarter and full year. Trade issues were clearly a non-event to him too. Buffett did comment that the new tax rules favorably impacted not only his earnings but added big time to the intrinsic value of Berkshire.

The bottom line is that Buffett remains the eternal optimist and ultimate investor. It does not hurt that he has a successful and growing insurance business that provides a huge investable float that provides him added liquidity to take advantage of market weakness. His long-term record speaks for itself and is just phenomenal.

We, too, have core beliefs that have served as our True North successfully guiding us over our 40+ year career successfully managing money. Management is the key determinant, as with Buffett, in making any investment decision. It is ironic that Buffett constantly puts down active money management as he believes that the average professional cannot beat the market. Not true!  The truth is that Buffett, Munger and their team are the ultimate active managers who believe in concentrated portfolios. We pride ourselves with the fact that we, too, are active managers and have consistently outperformed the markets over our 40+ year careers.

Another core belief is that we analyze that global supply of and uses of capital. We were concerned in October that the Fed could precipitate a recession in 2019 if they continued on their path of raising rates and unwinding their balance sheet by $50 billion per month. We also knew that the ECB wanted to end its aggressive easing monetary policy too. China, at that time, was trying to de-lever and end off balance sheet lending which meant tightening monetary policy. We concluded that global growth would slow rapidly in 2019 so we shifted our portfolios to defensive stocks.  We did a 180 turn by year end as the Fed capitulated; Bank of China reduced capital ratios and flooded their economy with cash, and the ECB was about to change its stance too.

We therefore shifted our portfolios once again, too, as we no longer feared a recession in 2019 while stocks were selling at recession levels. We also felt that the chances of reaching trade deals had improved too, as the risks to the downside were too large to ignore by the powers to be. In addition, we were growing more confident that foreign governments would be pressured to stimulate their economies by loosening their purse strings, spending more and not worrying about rising near term deficits. After all, the risks were to the downside with rising deflationary pressures.

So where do we stand now?

We have maintained our view that the global economy would continue to decelerate into mid- 2019. We also felt that newfound global monetary ease would effectively stabilize the global economy and growth could accelerate into 2020 benefitting from global monetary/fiscal easing combined with trade deals being reached, lifting a huge cloud over the business community. Again, why would a company hire and spend on new plant without some certainty about trade flows. Remember that growth won’t resume overnight even if trade deals are reached but the financial markets will anticipate all the benefits right away.

It is clear that President’s Xi and Trump want to reach a trade deal. We expect Trump to extend the current talks without additional tariffs for another 60 days beyond the March deadline setting up for a meeting between the two leaders to finalize a deal at Mar-a-Lago around April 1st.  On the other hand, we remain concerned whether the U.S. can reach a deal with the Eurozone before auto tariffs are enacted by President Trump. Nonetheless, we expect that Trump would attempt to reach deals with the Eurozone and Japan before 2020 when he runs again for President.  

Just imagine what kind of year 2020 can be if countries prime their economies, monetary authorities remain overly accommodative and trade deals are reached. No one is anticipating that occurring nor is the market priced for accelerating global growth next year.

We have positioned our portfolios to benefit from economic growth into 2020. If the global economy does indeed accelerate later in the year, we would expect yield curves to steepen, the dollar to weaken, commodity prices to rise and much higher global stock prices as earnings estimates are hiked.

Another core belief is own companies that are best in breed. That means excellent managements with winning long-term strategies; rising volumes, pricing and operating margins; strong financials with increasing free cash flow, and  currently priced well below intrinsic value.

Our portfolios include health care companies benefitting from new products; industrial and capital goods companies; technology at a fair price to growth; domestic steel and aluminum; housing related companies; and many special situations where managements are working to close the gap between current stock price and intrinsic value. We do not own bonds and are flat the dollar although we expect it to decline later in the year.

Remember to review all the facts; pause, reflect and consider mindset shifts; analyze your asset mix with risk controls; do independent research and …

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

 

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