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Berkshire Hathaway CEO Warren Buffett is well known as the “Oracle of Omaha” to a legion of investing disciples who eagerly await the last Saturday in February, when his annual letter to shareholders is posted. Buffett’s letters always contain valuable historical perspective and timeless investment advice, which are critical during scary times like now.
Stocks represent business ownership sliced into small pieces. Buffett noted in his just-released letter that, long ago, buyers “usually thought of their shares as a short-term gamble on market movements.” Further, “even at their best, stocks were considered speculations.” In fact, that’s unfortunately still true for a great many “investors” today.
“We constantly seek to buy businesses that meet three criteria,” Buffett said. “First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price.
“When we spot such businesses,” he continued, “our preference would be to buy 100% of them. But the opportunities to make major acquisitions possessing our required attributes are rare. Far more often, a fickle stock market serves up opportunities for us to buy large, but non-controlling, positions in publicly traded companies that meet our standard. Whichever way we go—controlled companies or only a major stake by way of the stock market—Berkshire’s financial results from the commitment will in large part be determined by the future earnings of the business we have purchased.”
On Berkshire’s 10 largest stock-market holdings (American Express, Apple, Bank of America, Bank of New York Mellon, Coca-Cola, Delta Airlines, JPMorgan Chase, Moody’s, U.S. Bancorp and Wells Fargo), Buffett said, “It is certain that Berkshire’s rewards from these 10 companies, as well as from our many other equity holdings, will manifest themselves in a highly irregular manner. Periodically, there will be losses, sometimes company-specific, sometimes linked to stock-market swoons. At other times, our gain will be outsized.”
Most important, Buffett and Vice Chairman Charlie Munger do not view Berkshire’s holdings as a “collection of stock market wagers—dalliances to be terminated because of downgrades by ‘the Street,’ an earnings ‘miss,’ expected Federal Reserve actions, possible political developments, forecasts by economists or whatever might be the subject du jour.”
This takes us to the subject du jour, the coronavirus scare of 2020.
We would never claim to be as skillful as Buffett, but also approach buying stocks by taking the perspective of owning 100% of the underlying business. The owner of the business is entitled to the future cash flows generated by the business. The intrinsic value of the business is simply the cumulative amount of those future cash flows, discounted back to today (i.e., the discounted present value of the future cash flows). We look for stocks priced well below our calculation of intrinsic value, with the intent of holding the stock/owning the business for 10 or more years.
While stock prices can be extraordinarily volatile (as they have been recently), the intrinsic values of the underlying businesses are much less so. “If you’re buying a business, and that’s what stocks are … you’re going to own it for 10 or 20 years,” Buffett said in an interview on MSNBC following the release of his letter.
“The real question is: ‘Has the 10-year or 20-year outlook for American business changed in the last 24 hours or 48 hours?’” I’d ask, “If you owned a thriving family business for 20 years, would you sell it for dramatically less versus two months ago simply because of coronavirus fears?”
I think the answer to both questions is an emphatic “NO!” Nobody knows how long and far the coronavirus outbreak will go or how it will end. The uncertainty is scary. In a global economy, near-term cash flows will be hurt, but cash flows going out 10 or 20 years will not be. In other words, we’re confident this will prove to be a temporary and not permanent impairment of intrinsic value and a better buying opportunity.
Indeed, in the interview, Buffett noted Berkshire is a net buyer of stocks over time, just as he is a net buyer of food, so he welcomes times when stock and food prices decline. “Who wouldn’t rather buy at a lower price than a higher price?” he pondered. “People are really strange on that. They should want the stock market to go down—they should want to buy at a lower price. We certainly won’t be selling.”•
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Kim is Kirr Marbach & Co.’s chief operating officer and chief compliance officer. He can be reached at 812-376-9444 or mickey@kirrmar.com.
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