Buffett Record is One Thing, Outlook Quite Another

Before you go out and buy a stock simply because Warren Buffett either has owned it for a long time or recently purchased it, consider the following quote from his letter to shareholders, released yesterday.

“Expect no miracles from our equity portfolio. Though we own major interests of a number of strong, highly-profitable businesses, they are not selling at anything like bargain prices. As a group, they may double in value in ten years. The likelihood is that their per-share earnings, in aggregate, will grow 6-8% per year over the decade and that their stock prices will more or less match that growth.”

What should investors gleam from this statement? Should they take it at face value, or just assume Buffett is being modest and trying to keep expectations low so he can exceed them more easily? If you are one of the many people who have asked me about my views on some of his larger holdings in recent months, you already know where I stand on this issue. Take what Buffett says as the truth. His days of drastic outperformance are long over.

Consider Berkshire Hathaway’s performance in 2005; up 6 percent using the metric Buffett prefers. That compares with 5% for the S&P 500 with dividends reinvested. A solid year, but hardly something that one should bend over backwards to mimic. It also is right around the 7% estimated growth rate he offered in his letter.

Consider Berkshire’s largest holding as of December 31st; more than $8 billion dollars of Coca Cola (KO). Coke stock has been dead money for 10 years, even as the S&P 500 has nearly doubled, as the chart below shows.

I will repeat here what I have told those who have asked. I would not expect shares of Berkshire, or Coca Cola, or Anheuser-Busch, or Wal-Mart, or Proctor & Gamble, or Washington Post, or any of Buffet’s other large holdings to make you rich from here on out. They were all great buys at some point in time, say 15 or 20 years ago, but now they are richly priced, even as growth prospects have diminished greatly as they have grown into industry behemoths.

Why then does Buffett continue to hold these stocks, even if he only expects them to return 7% per year? The answer lies in the fact that he has said his ideal holding period for a stock is “forever.” If I was to argue with Buffett on one aspect of his investment philosophy, that would most likely be the one I would choose. Holding a stock “forever” will ensure you own it during both the good times and the bad times. The latter is something investors should strive to avoid.

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7 Thoughts on “Buffett Record is One Thing, Outlook Quite Another

  1. Andy Kern on March 7, 2006 at 2:03 PM said:

    The rationale behind Buffett’s hold-forever philosophy is tax avoidance. That is, if he never sells, he can defer taxes on his gains indefinitely. Thus, he has been able to accumulate wealth in some cases tax-free. No trader will ever be able to do that. For a company like Berkshire, this strategy results in a rather sizable deferred tax liability on the balance sheet. But Buffett is happy to accept this liability because, unlike every other liability, this one carries no interest. So he thinks of his deffered taxes as zero-interest loans. This doesn’t mean, though, that he never sells stocks. He will sell if the economics of the business have changed for the worse or the competitive advantage the firm once had is no longer as strong. But for those companies that are still going strong, he sees no reason to trade in and out of them, because such behavior just results in unnecessary and costly taxes.

  2. Chad Brand on March 7, 2006 at 2:19 PM said:

    Tax avoidance may be his reasoning, but do you think if he knew that Coca Cola stock would be dead money for a decade that he would still keep it his largest holding, simply in order to avoid paying 15% capital gains taxes? Seems to me he could have made that 15% and much more by investing that $8 billion in something other than KO during the last ten years.

    Whatever the answer, I just think investors need to be aware that Berkshire is no longer a vehicle that Buffett is using to attain superior investment returns with. The KO holding seems to serve as evidence of that fact, as does his comment that he will continue to own companies that have average earnings growth coupled with less than attractive valuations.

  3. Andy Kern on March 7, 2006 at 2:30 PM said:

    I am sure he didn’t know Coke would be dead – especially since he has called it one of his three “permanent holdings.” That commitment will probably come back to haunt him because, I agree, Coke is in rough shape right now. I am sure he could have done better with something else, even after paying a hefty tax bill. However, the universe of companies available for $8 billion investments is rather limited, so it may not have been as easy as it seems.

  4. Chad Brand on March 7, 2006 at 2:42 PM said:

    That last sentence is the key. Given that he seems to only want to work in the mega cap universe to stay concentrated, his options are too limited to make outsized gains. Anheuser-Busch on its own doesn’t look all that great, but when you apply Buffett’s criteria to those companies with market values of $25B and above, you can at least understand why he bought it.

  5. Jay Walker on March 7, 2006 at 9:31 PM said:

    As both of you say, it’s not that easy to redeploy billions of dollars. Furthermore, 10 years ago, Coke looked like a fabulous money machine. It’s only then visible blemish (aside from its lofty valuation) was its slowing revenue growth. Everything else was unbelievably productive within “The Coke Machine”. Return on capital was very high, and marginal return on capital, even higher.

    So now you and I have the benefit of a crystal ball – one that we lacked in 1997. Except for the valuation, I would have bought as much KO as I could have afforded back then.

    Buffett doesn’t like to leave those companies with such high brand equity.

    Besides, if anyone checks the metrics, I think they’ll see that KO is well into turning it around: the stock market disbelieves it however, having seen too many false starts and broken promises.

    JW

  6. Chad Brand on October 27, 2010 at 9:43 AM said:

    @Muthu:
    I agree that he has picked good managers for his operating companies, but investment managers? This is really his first try there so the track record remains to be seen. Do we give him the benefit of the doubt? Sure. Are there things they might have liked about him that make up for the lack of track record? No doubt, and I am sure they care a lot about how good of a “fit” he is for their general philosophy.

    All of that said, if I was a shareholder I would have hoped for a little more. With the stock at more than 2x tangible book value and 11 times cash flow, it is richly priced historically, so I think this choice is quite important for the future performance of the shares.

  7. I consider Buffett to be very astute in picking the right companies and right managers. That’s what his track record say so far.

    If the information given in your article is accurate, I wonder if Buffett can be dumb in a very important decision of his successor. Looks unlikely. Is there any information we are not aware in public domain about Todd Combs, which Buffett and Munger knows. May be. Given their track record, can we give them benefit of doubt?

    Last month only Munger hinted that Li Lu is a likely successor. What has happened in the last one month, which changed things?

    More questions. Less answers.

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