Value investing
KAREN GIBBS: Few people receive the attention given to Warren Buffett, known as the Oracle of Omaha. He's the brains and brawn behind Berkshire Hathaway, a holding company that owns and operates such diverse businesses as insurance, jewelry, corporate jets and Dairy Queen, just to name a few.
Oh, did I mention he's the second richest man on the planet?
But Buffett's real fame comes from his reputation as an investor extraordinaire, and just this week, Buffett told the world he doesn't like U.S. stocks and is putting money overseas.
Maybe it's a coincidence, maybe not, but the markets tanked this week: The Dow losing over 355 points, the Nasdaq off nearly 63 points, and the S&P tumbling over 36. The Dow and the Nasdaq are now in the minus column for the year.
So how can individual investors walk in Buffett's path? Edwin Walczak is a Warren disciple whose Vontobel Asset Fund is loaded up on Berkshire Hathaway stock. And Jean Marie Eveillard is a renowned international investor running the First Eagle Global fund.
GIBBS: Well, Jean-Marie, U.S. stocks had a great run in 2003, but have given back all their gains year to date. What's going on?
JEAN MARIE EVEILLARD: Well, what's going on from my own point of view is, American stocks are on the expensive side. Now it doesn't mean that the stock market cannot work its way higher. It simply means that stocks are vulnerable, and this week they proved to be. There is also the matter of imbalances that developed during the bubble years of the late 1990s, and very few of those imbalances have been corrected. So we are in, the world is a dangerous place for investors.
GIBBS: Well, Ed, let me read you something that Buffett said in his most recent shareholder newsletter. He says:
"Our equity holdings have fallen considerably. When we can't find anything exciting, our default position is U.S. Treasuries." Now that may be some comfort to U.S. investors that are sitting on about $2 trillion in money market funds yielding under 1 percent. But tell us why that's the best place for our money.
EDWIN WALCZAK: Well, it's better to get a yield on 1 percent than a loss of 15 or 20, as was experienced in the 1999-2000 year bubble phenomenon. So as Buffett says, and we fully share his investment philosophy, in our funds we have by default about a 30 percent cash position. We only bought one new stock all of last year. So I think as Jean-Marie said, equities have quite a good run. Neither Buffett nor we can market time, but it's simply harder these days to find good quality stocks at an attractive price. So when that's the case, why do something stupid? Just relax and let your money sit there, and life is long. One day a good opportunity will come along.
GIBBS: Well, something else that was revealing in Warren Buffett's letter, he says:
"In recent years our country's trade deficit has been force-feeding huge amounts of America to the rest of the world, so I feel more comfortable owning foreign exchange contracts."
Jean-Marie, do you think that that was a departure from Buffett's normal style of investing?
EVEILLARD: Yes, it was a departure, and he himself pointed out that it's the first time -- and he's 73 (years old) -- it's the first time ever he did it in his investment life. But I think it's a matter of Buffett making an exception in what he sees as exceptional circumstances. And again, if there is indeed a dollar crisis -- and again I'm not predicting it, and if it happens, I certainly don't know when it will happen -- but if there is a dollar crisis, then one has to protect oneself through various safe havens or hedges, and foreign exchange is one, and that's what Buffett did to the tune of $12 billion.
GIBBS: Ed, Warren Buffett is a very sophisticated investor. How can an individual investor who is unable to participate in direct foreign currency purchases make a play on this falling dollar?
WALCZAK: Well, it's beyond me how they would do it. I would not recommend that, frankly. Because actually, I think even before you get to your average individual and whether they should be bullish or bearish with currency, I think one might even ask is Warren Buffett capable of making an intelligent call about currency, given this is a bit out of his investment expertise historically. One may wonder whether he's being somewhat inconsistent here and somewhat speculative. His message to us over the years has always been study businesses, stay within your circle of competence, invest in things you know, try to value stocks using something called intrinsic value or of a level below you're almost certain it would not logically fall. And I wonder if what he has done here might be a somewhat different type of investment than he's made in the past even for himself, let alone your average individual should try to emulate what Buffett has done.
GIBBS: Ed, Buffett was a little pessimistic in terms of corporate governance. Let me read you what he said. He said "Judging whether corporate America is serious about reform, CEO pay remains the acid test, and the results aren't encouraging." Well, what does this say then about investor confidence going forward in corporate America?
WALCZAK: Well, you know, I think if you follow some of Buffett's own investor principles, the answer lies within. I mean when I look at some of the stocks we have owned in the past, we may not own them today, but we're really looking for companies where inside ownership is very significant. Let me give you a couple of examples that are non-Michael Eisner like.
Look at Golden West Financial, GDW.
It's a savings and loan run by Herb and Marion Sandler, both of which are tremendously wealthy individuals. They work because they love it. Their own equity is on the line every day. It's got to be the best-run savings and loan in the United States. I think it's one of the top performing stocks in the U.S. for the past 20 years. I think the fact that this huge insider ownership has made for a certain ethical standard in the firm, a certain cost-cutting standard in the firm. They deliver for themselves, and they deliver for the shareholder. No surprise. It's their money on the line with the shareholders.
I'll give you another example, Mercury General, MCY, an automobile insurance company in California.
(Mercury Chairman and CEO) George Joseph is an 80-year-old billionaire. What's an 80-year-old billionaire doing working every day? He loves it. It's his life. Just like Buffett, and look at Buffett. What percent of his net worth is in Berkshire Hathaway? Ninety-nine percent I believe, if not higher.
So I think what shareholders can look for to avoid the unseemly things that have been happening out there, whether it's in the mutual fund business or corporate self-aggrandizement, is look for companies that you can understand. And it's quite helpful if you have the people who are running the show have their own equity big time on the line along with you, the shareholder. That will protect here a lot.
GIBBS: But, Ed, you've got to agree with me that it's very difficult for the individual investor to always uncover these things. Take Warren Buffett, for example. He was blindsided by the problems at General Re, General Re Insurance Company, one of his major holdings, and the underwriting policy. So how are individuals expected to sort this stuff out?
WALCZAK: Well, that's an interesting opposite perspective. Let me say up front, nobody can know everything about everything, first of all. So even though Warren Buffet is perhaps, obviously he's got one of the best records in the history of mankind, he's not infallible and not everything is knowable.
GIBBS: Ed, you mentioned buying stocks or companies that you know. What stocks and companies that you know are you willing to buy now?
WALCZAK: We want companies that we can trust, understand and depend on, i.e. we don't want to lose money, and then if that qualitative company is attractive, it's a candidate for purchase. And again, if we can't find anything sensible to do, we do nothing. We only bought one new stock last year, Fifth Third Bank. Well, we've just bought some Mohawk Carpets recently at about $82 a share, and that's a business that's not to hard to understand. I mean, you know, Buffett owns Shaw (Industries) Carpets in his portfolio.
GIBBS: Jean-Marie, last year we talked around Valentine's Day, and you were looking at some overseas stocks, but you also saw some very interesting opportunities here in the United States. Barnes & Noble was one, McDonald's, you nailed it right on the head, and also Liberty Media. How do you feel about those stocks now? Are you still buying them?
EVEILLARD: Well, Barnes & Noble and McDonald's, they've moved up considerably. We still own them, but we would not buy more. They're already large holdings of ours. The stocks are selling approximately at fair value. We don't mind holding them because we think both can continue to create value in the future, additional value.
In the case of Liberty Media, on the other hand, the stock has not moved much. It's between $11 and $12. It's a collection of good media assets, which are priced reasonably.
GIBBS: Ed, you have a sizable holding of Berkshire Hathaway shares, coming close to, is it $93,000 for the class A shares? Are they getting pretty expensive, and when would you sell?
WALCZAK: Well, unlike Buffett, well, Buffett's probably a lot smarter and a lot richer than we are, but that's a given, that's okay, but the principal difference between Buffett's style and our own is we are not buy and hold. We had up to 15 percent of the fund in Berkshire Hathaway in recent years. We weren't, we haven't owned Berkshire Hathaway forever. It has only been post-2000 that we came to own Berkshire. We always thought it was rather richly priced. But it's not $48,000 a share anymore, you're quite right. It's $93,000, $94,000 a share, and we've cut back. We have cut back from 15 percent of the fund to 9 percent of the fund where it is today, so we've taken some profit also in Berkshire Hathaway.
GIBBS: Ed Walczak, Jean-Marie Eveillard, thanks so much for joining us.
WALCZAK: Thank you.
EVEILLARD: A pleasure, Karen.
GIBBS: If it were a mutual fund, Berkshire's equity portfolio would rank in the top 10 of all stock funds. We've received a lot of letters from viewers asking how they can get a piece of the Buffett action? There are actually three ways.
You can simply buy stock in Berkshire Hathaway, but at $93,000 a share, it's a bit costly.
There's also a Class B of the stock selling for around $3,000.
Then of course you can buy actual mutual funds like Ed (Walczak)'s that are heavily invested in Berkshire Hathaway stock. The leaders there are: Sequoia; New Market; Fairholme; and Ed's Vontobel U.S. Value, now marketed as Janus Adviser U.S. Value.
(Online note: Chart currently unavailable for New Market, AVMIX)
And there are the Buffettologists, managers who may or may not own Berkshire Hathaway stock, but try to invest as if Warren were looking over their shoulders. Good examples here are Wally Weitz's value fund, and Robert Hagstrom's Legg Mason Focus Trust:
Wally Weitz
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Robert Hagstrom
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Investing from magazines
GEOFF COLVIN: One of the main features of Buffett-style value investing is running away from the crowd, zigging when they zag. And a classic tool is the magazine cover indicator. When a company or person or trend lands on the front of a major national magazine, goes the theory, you should tear in the opposite direction. Perfect example: Amazon CEO Jeff Bezos was Time magazine's person of the year in December, 1999, almost the exact peak of Internet mania. Amazon was over $100 a share at the time. One year later it was $16.
Why the indicator works is no mystery. Barry Ritholtz, a market strategist with Maxim Group, actually keeps track of it:
BARRY RITHOLTZ: Magazine covers are telling you what's something that's already resonated throughout society, and investing is about anticipating where a particular stock or where a particular trend is going to work its way out to. At the end of the trend is usually too late to be a buyer. You want to be on the other side of that.
COLVIN: By far the most famous magazine cover contra-indicator was Business Week's legendary "Death of Equities" cover in August, 1979 -- when we all should have begged, borrowed, and stolen as much money as possible and put every penny into equities. Or how about this Newsweek cover: "The Real Estate Bust," October 1990, just before the greatest real estate boom in history.
A few weeks ago Forbes declared "Tech is Back!" The Nasdaq is since down about 6 1/2 percent. And even at FORTUNE, I have to admit, the same thing happens occasionally. This cover from last July coincided almost precisely with Krispy Kreme stock's all-time high.
What's next?
RITHOLTZ: I'm waiting for the following magazine covers to come out. One is going to be: "How low can interest rates go?" And you'll see a chart of interest rates over the past 20 years, and in the late '70s they were 18 percent and now they're 2 percent. That'll probably mark the bottom of the interest rate cycle. And then on the other side, I'm waiting for the cover that's going to show a gushing oil well and say: "$45 a barrel oil? How high can it go?" And that will very much mark the top of it.
COLVIN: The magazine cover indicator does seem almost cosmic. We didn't put it this way, but New York Times columnist Paul Krugman did when he wrote, "Whom the gods would destroy, they first put on the cover of Business Week."
That was Jeff Skilling, a laudatory article in February 2001, which would have been a great time to bail out of Enron.
Siegel & Shiller disagree
COLVIN: With the Dow up 30 percent in the past 18 months, you may be wondering if you should bail out of the market. For insight on that we turned to the Lewis and Clark of investing -- good friends and intrepid explorers, except in this case they didn't end up in the same place.
Professor Robert Shiller of Yale and Professor Jeremy Siegel of Wharton are Ph.D economists, respected authors -- and they're directly opposed on what you should do with your money now. Siegel wrote Stocks for the Long Run, showing that historically, stocks have been by far the best investment. Shiller wrote Irrational Exuberance, arguing that even today, stocks look dangerously expensive. I sat them down recently after they'd made their cases to an audience of 3,000 at the Richmond Forum in Virginia, and got them to sort this out head to head.
Professor Shiller, he (Siegel) has got 200 years of data showing that stocks are overwhelmingly the place to put your money. Why shouldn't we just say case closed?
ROBERT SHILLER: Well, you used the present tense. I absolutely agree case closed for the last 200 years, for the long-term investor, stocks were the place to be. But this is something called the 21st century, and the relevance of the 20th and the 19th century is not clear. We are in a period where prices are high in the stock market, and the idea that we'll just repeat the last century is without any scientific foundation.
COLVIN: And you think there are reasons to believe we won't.
SHILLER: Well, because the prices are so high, and they're supported right now by still a lot of investor confidence, and investor confidence is a fragile thing. It has had ups and downs in the past.
COLVIN: Professor Siegel, you've got this enormously impressive set of historical data, but to answer Professor Shiller's question, why should we believe that history will repeat itself?
JEREMY SIEGEL: Well, all we have is history, and to guide us for what happened in the past, to look at what's going to happen in the future. And I agree with Bob. Prices are high. But you know what? They should be high. There's lot of very good things happening in the economy, the liquidity in the economy, low transactions costs. I think historical price/earnings ratios should not be the guide for looking at what stocks will yield in the future.
COLVIN: So we should still be putting money into stocks now.
SIEGEL: For long-run investments, I still think it should be the cornerstone of the portfolio.
COLVIN: Long-run meaning 10 years or more?
SIEGEL: Yes.
COLVIN: Well, Professor Shiller, as you have often said, you've got to put your money someplace. If you don't want to put them in stocks, where do you want to put your money?
SHILLER: Well, I'm not against stocks altogether. I think that one should diversify. And people often think that diversification means merely keeping to a number of different stocks instead of just one stock or one industry. But it really means diversifying beyond the stock market. And that's why the other investment classes are bonds and real estate or in cash, and so one should be spread out over those.
COLVIN: Now I've heard you recommend in particular savings bonds. What are you thinking there? It surprises a lot of people right?
SHILLER: They're the safest thing in the world, whereas stocks, there is a risk that this stock market is going to plunge again. I mean it's priced high. Jeremy will agree, there is a risk. And so as a part of one's portfolio, these simple Government savings bonds - you can't put more than $30,000 a year - so slam $30,000 a year into them right now, and I think that's a very sensible thing.
COLVIN: The name of your previous book was Irrational Exuberance, and in light of all that has been discovered in recent years by behavioral economics, people conducting experiments on how real folks actually behave with regard to their investments, you have to wonder if maybe everything in the stock market isn't in fact irrational. Do you believe that?
SHILLER: I think for the aggregate stock market, most of the movements are irrational. I've done work on this and looked at interest rates, subsequent dividends, the subsequent earnings. Nothing really has explained the major ups and downs of the stock market. There's no rational good sense for it.
But if you look at individual stocks, it's different. The real difference is that for an individual stock, there's a lot of information that comes through about what that company is doing. And if good information, like a drug company has a new breakthrough or if it doesn't get FDA approval, those things have real meaning, and the stock immediately adjusts, and we know why the stock did that.
The stock market, the aggregate earnings is a much smaller, difficult animal to predict. And so the market is trying, but it's going wild trying to predict the future.
COLVIN: Professor Siegel, does it make sense to you that individual stocks can respond rationally and yet the market overall, when you add them all together, is behaving irrationally?
SIEGEL: Well, what Bob is talking about, individual stocks respond to their own earnings development, discoveries, and good things or bad things happening within the company. And it is true that most researchers have found that that's a pretty efficient market. That means it's very hard to pick individual stocks that are going to outperform.
It is true that a lot of the movements of a stock market are not due to economics, but to say that nothing is due to it, or almost nothing, is not true. For instance, the market almost always goes down, I think it almost always has predicted, in a way, recessions, economic recessions. Now there's been false alarms. We all know that. But, you know, bear markets have come before recessions, bull markets have come before recoveries. The time is variable. It's not always there. There are false alarms. But to say it's totally disconnected from what's going on I think is the wrong impression.
And I think that what's important is over the long run, these psychological, psychologically-induced wiggles that we see in the economy tend to iron themselves out. If you have to get out of the market a particular time everything, yes, you're taking a risk. If you're putting in overtime, dollar-cost averaging, looking towards the future and getting it out on retirement over periods of time, I think the risk is minimized in that case.
COLVIN: How are you allocated?
SHILLER: It's a complicated situation, because I have several companies …
COLVIN: You have companies of your own that have capital …
SHILLER: So I consider them correlated with the market. Outside of that, I have only about 15 percent in stocks, and half of that is abroad.
COLVIN: In foreign stocks.
SHILLER: Yeah, because I think the dollar is looking weak, and so when you repatriate the money, it will be with a better return.
COLVIN: More dollars.
SHILLER: So you're combining a stock investment with an investment …
COLVIN: A currency bet.
SHILLER: A currency bet.
COLVIN: Yeah.
SHILLER: And I've got a lot in real estate and I've got a lot in indexed bonds, and some in cash.
COLVIN: Okay, your turn.
SIEGEL: Okay. I'm 70, 80 percent in stocks. I do have some REITs, real estate investment trusts, and I do have personal real estate. I think both Bob and I have some personal real estate there. I don't want to get any higher, because I do think that when interest rates are rising, you know, that market is definitely going to cool down. I agree with Bob on the international. I'm moving more and more. I'm probably not as much into it as I plan to be into the future. It's not just a dollar threat of the dollar going down, but two thirds of the world's capital is outside the United States. And I think there's great growth in Asia, and I think that there's opportunities in the rest of the world and one should have some of your stocks abroad.
COLVIN: Now, first of all, of course you guys have known each other for many, many years, and until not that many years ago, you pretty much agreed, saw the world in the same way. Under what economic circumstances would that be the case once again?
SHILLER: Oh, very simple. After the market crashes. We'll both be bulls.
COLVIN: Thank you both so much.
Next week
GIBBS: Actually stock market crashes pale in comparison to the wars and strife caused by one commodity. Next week we're going to show you why water may be the great investment idea of the new millennium.
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