Warren Buffett's attitude when he has lots of cash but shares seem expensive

We can learn a lot from the way Warren Buffett behaved when the stock market was bounding ahead in a burst of enthusiasm.  Even though the story takes place over 30 years ago it is highly relevant for where we are today.  In the mid-1980s Berkshire’s controlled subsidiaries and security investments were bringing in hundreds of millions of dollars for Buffett and Munger to invest – see Table 1.

Table 1. Net earnings after taxes attributable to Berkshire Hathaway from operating businesses

$m		1985		1986		1987
Insurance underwriting		-23.6		-29.9		-20.7
Insurance investment income (dividends and interest)		79.7		96.4		136.7
Realised security gains		325.2		150.9		19.8
Buffalo News		14.6		16.9		21.3
Fechheimer		–		3.8		6.6
Kirby		–		10.5		12.9
Nebraska Furniture Mart		5.2		7.2		7.6
Scott Fetzer Mfg. Group		0		13.4		17.6
See’s Candies		14.6		15.2		17.4
Wesco – other than Insurance		9.7		5.6		5.0
World Book		–		11.7		15.1
Other		19.9		-4.9		4.3
Interest on debt		-7.3		-12.2		-5.9
Charity donations by BH shareholders		-2.2		-2.2		-3.0
TOTAL EARNINGS		435.8		282.4		234.6

(Source: Warren Buffett’s Letters to Berkshire Hathaway shareholders 1986-87)

But there was a problem for any value investor at that time: the stock market had been zooming away.  The Dow, a mere 800 in the early 1980s, more than tripled in five years to reach 2,709 in August 1987 – see Figure 1.

Figure 1. Dow Jones Industrial Average January 1980 – August 1987

The shape of the Dow curve is remarkably similar to the last seven years – see Figure 2.

Figure 2.  Dow Jones Industrial Average 2012-2019

Investors had been so pessimistic in 1980 and 1981 that they priced the typical American share at a mere 7 – 9 times the previous years’ earnings.  Then, as recession was put behind them, companies and shareholders gradually grew in confidence, and PERs rose to double figures – see Figure 3.

Figure 3.  S&P 500 price earnings ratio, 1980 – 90

Things started to get out of hand in 1986, and by August 1987 US shares we

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