Warren Buffett: Do as I say, Not as I Do: No Bubble, but Berkshire Hathaway’s Cash Hoard Soars

At a CNN interview, US President Obama crony Warren Buffett denies a bubble in US stocks: Buffett said stocks "might be a little on the high side now, but they've not gone into bubble territory."

Yet he further stated that:  "I don't find cheap stocks to buy either," he said, adding after follow-up questions that there were "very little" and "very few" bargains out there right now.

For Mr. Buffett, the framing of bubble in the context of portfolio management matters. 

In Berkshire’s 2014 annual report, Mr. Buffett wrote: (bold mine)

There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.”

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century. 

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray. 

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits. 

For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities

Yet action speak louder than words.

Berkshire Cash and Cash Equivalents since 1995

Berkshire cash at US$ 60.98 billion or 17% of market cap as of yesterday (based on Yahoo Finance).

The cash holdings of Mr. Buffett’s flagship Berkshire Hathaway has been skyrocketing.

From an annualized basis, Berkshire’s biggest gain in cash equivalent has been in 2014. Yet since 2008, Berkshire has been stockpiling cash reserves.

And the crux has been, Berkshire has done little to use those cash hoard!

While it may be true that “a multi-decade horizon, quotational declines are unimportant”, buying at a elevated prices will have an impact on portfolio returns even at the long run. 

And what Mr. Buffett didn’t say has been that most of Berkshire’s holdings has been from long term positions, rather than from current investments.

It’s true that Berkshire Hathaway recently bought $560 million in the automotive sector through Axalta Coating System, a 145-year old seller of coatings for cars, SUV’s and commercial vehicles, but this hardly signifies a dent on the $60 billion stash.

At least Mr. Buffett has been candid to admit that he is just human and has been subject to miscalculations and losses.

In the same annual report he shares the sad experience of Berkshire’s position with Tesco.

Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.

At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.

In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)

During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.

We sold Tesco shares throughout the year and are now out of the position. (The company, we should mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth. In the past 50 years, we have only once realized an investment loss that at the time of sale cost us 2% of our net worth. Twice, we experienced 1% losses. All three of these losses occurred in the 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper

Finally, yet some very useful advise from the annual report (bold italics mine)

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

The commission of the investment sins listed above is not limited to “the little guy.” Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game

Well, the above insight brings us back to Mr. Buffett’s old adage: 'You want to be greedy when others are fearful. You want to be fearful when others are greedy. It's that simple.'

So there you have it, for Mr. Buffett the term "bubble" seems as a political sensitive word. So he fudges this by framing the market over the long term versus the short term. 

Updated to add: Of course uttering the word 'bubble' may just deflate Mr. Buffett's glory, prestige and esteem, as the investing public would refrain from pushing up Berkshire Hathaway or assets held by Berkshire.

Yet in his 2014 annual report Mr. Buffett made lots of caveats in citing "borrowing has no place in the investor's tool kit" when US non-financial companies has been in a borrowing splurge, that makes markets susceptible to "anything can happen anytime in the markets".

And if one looks at Mr. Buffett's Berkshire’s Hathaway cash stash, they seemed positioned for a coming fat pitch…

So do as I say, not as I do.

Warren Buffett: Embracing Crony Capitalism

Warren Buffett used to be the person I wanted to emulate. Not anymore.

This is because Warren Buffett’s investment approach has radically changed. He has undergone dramatic transformation from a Graham-Dodd modeled value investor to a political entrepreneur-crony capitalist.

The Huffington Post writes, (bold highlights mine)

No matter what the government does, taxpayer bailouts of the financial sector will sometimes be necessary, according to the nation's second richest man.

As markets crashed in the fall of 2008, government officials feared that if certain financial institutions failed, the entire financial system -- or perhaps even the entire economy -- would come down with them. In the months after the government extended a $700 billion bailout to the financial sector, lawmakers have striven to ensure that no institution poses such a systemic risk that it would be too big, or too interconnected, to be allowed to fail.

But famed investor Warren Buffett, whose own firm profited handsomely from the bailout, said bailouts are an inevitable feature of finance, Bloomberg reports.

Buffett, who is personally worth at least $45 billion, told the government panel charged with investigating the causes of the financial crisis that its work would not prevent the phenomenon of "too big to fail."

Reading last night’s very timely article at Mises.org, Frank Chodorov wrote of how some capitalists have contributed to the advancement of socialism.

Mr. Chodorov wrote, (bold highlights mine)

The task of producing goods and services for exchange was accepted as a necessity, but the summum bonum was the acquisition from the king of grants, patents and subsidies that would yield them monopoly profits, that is, profits over and above what might be garnered in a competitive market. Their aim was to live like nobles who rendered no service for the rents they collected from their tenants.

It appears that such “rent seeking paradigm” seems to be Mr. Buffett’s newfound specialty.

Warren Buffett’s perceived “bailout-as-a-necessity” is due to the fact that he or his company profits from these. Yet, what is beneficial for him comes at the expense of ordinary people. Bailouts are basically redistribution of wealth from the average Americans to Mr. Buffett, his company and shareholders.

Nonetheless bailouts are not inevitable. Eventually a political economic system that persists in doing so will only degenerate. And this will likewise affect his company’s profits overtime.

Besides, bailouts or political concessions depend on patronage. Once Mr. Buffett’s political network has gone out of the loop then such privilege goes out of the window as well.

So instead of looking for economic opportunities to exploit on, Mr. Buffett and his executives will be focusing on lobbying.

This only goes to show how Mr. Buffett’s the time horizon has substantially narrowed. Maybe it’s because of age.

But Mr. Buffett has certainly been a disappointment, unlike his libertarian father, a staunch defender of the “old right”, Howard Buffett.

Warren Buffett: From Value Investor To Political Entrepreneur?

Warren Buffett has been widely known for his VALUE investing approach, largely influenced by his mentor Ben Graham.

But, lately our icon's political liberal leaning views, wherein he strongly supports government intervention in markets, appears to have similarly exposed a shift in his investing strategy, where Mr. Buffett's model appears to have evolved into investing under "government umbrella" or capitalizing on opportunities provided by the recent government sponsored bailouts.

In short, the reason he supports government intervention has been because he and his Berkshire Hathaway directly benefits from these.

Here is an excerpt from the splendid article from Reuter's Rolf Winkler, (all bold highlights mine)

``Today, Buffett remains famous for investing The Right Way. He even has a television cartoon in the works, which will groom the next generation of acolytes.

``But it turns out much of the story is fiction. A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.

``Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money. The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.

``To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee...

``He even traded the bailout, seeking morally hazardous profits in preferred stock and warrants of Goldman and GE because he had “confidence in Congress to do the right thing” — to rescue shareholders in too-big-to-fail financials from the losses that were rightfully theirs to absorb...

More of the rest of Buffett's conflict of interest here.

Nonetheless Mr. Winkler, apparently dismayed with the clash in the purist market based imagery against Mr. Buffett's actual practice, concludes, ``What saddens me is that Buffett is uniquely positioned to lobby for better public policy, but he’s chosen to spend his considerable political capital protecting his own holdings."

``If we learn one lesson from this episode, it’s that banks should carry substantially more capital than may be necessary. You would think Buffett would agree. He has always emphasized investing with a “margin of safety” — so why shouldn’t banks lend with one?"

So what do you call entrepreneurs who profit from government intervention?

According to Wikipedia.org, `` a business entrepreneur who seeks to gain profit through subsidies, protectionism, government contracts, or other such favorable arrangements with government(s) through political influence (also known as corporate welfare)" is known as a political entrepreneur.

And an economy that thrives on political entrepreneurship is also pejoratively known as "crony capitalism"-an allegedly capitalist economy in which success in business depends on close relationships between businesspeople and government officials. It may be exhibited by favoritism in the distribution of legal permits, government grants, special tax breaks, and so forth (wikipedia.org).

And I mistakenly thought that political entrepreneurship only existed in "banana republics" characterized by mostly autocratic rulers (or even manipulated democracies) under unfree economies.

Has the political economy changed so much that has compelled our icon to shift strategies?

Or has Mr. Buffett's performance been a chronic "mythologizing a humble background"- typical of tycoons as Joe Studwell in Asian Godfathers observed-where reputation and reality do not match?