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Warren Buffett sent what at first glance seems a confusing message to investors when speaking at Berkshire Hathaway’s virtual AGM on Saturday. On the one hand, he reaffirmed his conviction to always back the “American miracle” by investing in US companies. You should never bet against continuation of the miracle, he says. The country is set up in such a magnificent way that the US economy will thrive, driven by the capitalist culture nurturing excellent companies, which will raise living standards.
On the other hand, he said that in April Berkshire sold over $6bn of shares, and bought only a handful (not Buffett’s buying, but Todd and Ted’s – his assistant capital allocators).
Furthermore, while in January and February he was content for Berkshire to buy its own shares because they were selling too cheap in the market, in March and April, even though BH shares had declined by around 30%, he chose not to.
Berkshire has $124bn in cash or near cash (Treasury bills) and yet Warren Buffett says that he cannot find anything of quality selling at a reasonable price.
How to reconcile this seeming contradiction
It is to do with time-spans and value. While the American miracle is long term phenomena, and here we are talking about decades – in 20 or 30 years from now the economy will be much bigger and companies will be producing much larger profits of owners of pieces of those business – regarding the next week, next month or next year Buffett says he doesn’t know if the market will be up or down. The miracle might go through a bad patch, as it did in the Civil War or the 1930s – or it might not.
And then there is value. In January, the range of potential future scenarios for company earnings, including Berkshire, were seen as being concentrated in a band at a fairly high level.
But the facts have changed. The profits of many businesses will now be wiped out over the next year or two and there is an existential threat to many companies, e.g. airlines, retailers and hotels. And the economic scars might continue long after the next 24 months.
Therefore, logically, our estimations of the discounted future cash flows that business owners can take away (owner earnings) are significantly lower now than they were in January.
The range of scenarios has shifted to the darker side of the spectrum. Therefore, what is considered a reasonable price for a share has shifted downward.
Berkshire has insurance companies, retailers, aerospace parts producers, and railroad companies hauling oil – all are suffering. Even Cola-Cola sales are down by one-third and the big banks are bearing large loan write-offs.
This collection of companies will not generate as much as was earlier supposed. Therefore, while Berkshire’s shares were selling at below intrinsic value in January and so Buffett bought, they are now priced by Mr Market at above the new intrinsic value.
Similarly, Buffett can’t find other companies’ shares selling below intrinsic value with a sufficient margin of safety.
Perhaps things will turn out less bad than Buffett thinks. Perhaps the lockdowns will end next month, and we’ll all get back to normal, flying again, going to the cinema and the pub again. And then intrinsic value (discounted future owner earnings) will be larger and justify purchases. Clearly, after the large rise in the US indices in April Buffett is not tempted by what is on offer.
Buffett’s optimism about America
“I was convinced of this in WW2, during the Cuban Missile Crisis, 9/11; and I was convinced of this in the Financial Crisis: nothing can stop America. We’ve faced great problems in the past and the American miracle, the American magic, has always prevailed, and it will do so again.”
A little perspective:
Covid-19 may be bad, but the current time is still great, “If you were to take one time to be born and one place to be born, you would pick today and you would pick America.”
Taking the long view:
“In 231 years this country has exceeded anyone’s dreams. The wealth of the US is now $100tn, at least $100,000 per each original $1 spent [on the Louisiana Purchase]. We’ve now hit a bump in the road. [The advance of America] was not done without some very, very serious bumps in the road.
It was not 231 years of steady progress. In the Civil War about 6% of males aged 18-60 died. In another crisis, the Dow Jones Industrial Average, DJIA in September 1929 was 381.17. People were very happy buying stocks on margin in the Roaring Twenties [only putting $10 down say on a $50 stock].
By November 13, 1929 the Dow almost was cu
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