A Well Reasoned Response

Today's posting is a rebuttal to my article on August 25th about Warren Buffett's seemingly conflicting stance on stocks and investing. I feel that this response is so important that everyone could learn from it. I will add my response in the comment section if you are interested.

By RandFan

"To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions." -- Warren Buffett, from "Buy American, I Am."

Buffett's message has never changed over the years...but market conditions have....

"Even if you agree that the 12 percent equity coupon is more or less immutable, you still may hope to do well with it in the years ahead. It's conceivable that you will. After all, a lot of investors did well with it for a long time. But your future results will be governed by three variable's: the relationship between book value and market value, the tax rate, and the inflation rate." Warren Buffett, from "How Inflation Swindles the Equity Investor"

The author of "Will the Real Mr. Buffett Please Stand Up" is either a very sloppy student or a Sophist trying to stir up controversy. To make this argument, you have to make two fatal assumptions: 1) For the equity investor, 1977 is functionally equivalent to 2008 and, 2)An "equity investor" is functionally equivalent to a "value investor." Regarding the first fatal assumption: Market value to book value for many excellent companies was much lower in late 2008 than it was in 1977, so the "investor's equation" produced a different signal. Tax rates were also much higher in 1977 (and may not reach that level again for some time because of today's political climate--a point Buffett made recently in a NYTimes OP-ED piece)which effects return on book value and, thus, the results of the investor's equation.

Throughout his career, Buffett has allowed his disciples an audience to his life-long process of learning. He carries on "out loud" mental discussions with himself as he incorporates new, conflicting data into his world view and through a process of creative destruction strengthens his understanding. His 1977 article is, I think, simply an academic exercise for him. He just so happens to be letting the world in on it. He's going about the process of reconciling information which contradicted truisms that he had learned earlier in life from sources such as John Burr Williams' "The Theory of Investment Value," a book which I highly recommend to anyone who is interested in understanding what Buffett means by "the investor's equation." At any rate, long story short, this is just another pseudo-controversy about Buffett that boosts web-hits and proves that age-old frailty of man: Envy.

Please revisit Dividend Inc. for editing and revisions to this post.

3 responses to “A Well Reasoned Response

  1. Dividend Inc. Team

    Ranfan,

    Your point is well taken. In fact a good friend of mine stated his remarks to the same article as such:

    "…there are several aspects to what he was saying then, and now, which need to be considered as well.

    For instance,

    — It is well proven that inflation lowers the intrinsic values of corporations because inflation raises the corporate bond yields This forces the discount rate higher for the corporations. Thus, making the present value of discounted cash flows lower and thus lowers the intrinsic values.

    — The reason for the huge wave of new equity offerings in the recent past is, I believe, corporations are trying to beat the incoming monstrous surge in inflation. They want to lower their debt/equity ratios in order they can survive the future onslaught. Again, the reason could be: the rolling over the debt is going to cost them a whole lot more in the future.

    — Buffett has been consistent in his Annual Reports to the shareholders with respect to the perilous effects of inflation on virtually all corporations, and since inflation robs the purchasing power of the individuals too, inflation is bad for everyone, period. In October he was pushing stocks for maybe two reasons: He was speaking on behalf of the Obama Administration (of which he has been an ardent supporter) and trying to prevent or at least lessen the panic attack the financial world was experiencing. Something similar to J.P. Morgan who barged onto the floor of the NYSE one day during the horrific 1930's and shouted out orders to his broker-dealers, "Buy, Buy, Buy". (Do you recall when this actually happened?) Buffett couldn't say "I am buying GS and MS but you guys better be careful out there"! (The reason he was buying the convertibles of those companies was the 10% dividends.)

    — The other possibility why Buffett was so positive in October could be this: If GS and other financial titans had collapsed, BRK would have taken a semi-fatal hit too, and his fiduciary duty to his own shareholders was to do what he did.

    — In October when he said inflation would cause a decline in the real value of cash he was right to imply that corporations' ability to produce real return will always be higher than that of cash. Cash has a negative coupon due to inflation, whereas corporations never do or else they would liquidate their assets and stay in cash. So he was comparing cash to equity and nothing more, I believe.

    …to be continued

  2. Dividend Inc. Team

    It is clear, Randfan, that you are correct that Buffett's open dialogue is available for everyone to read. However, too many people are influenced by his words without having the faintest idea of what he is talking about.

    This multitude of people who follow Mr. Buffett, CNBC, WSJ, BusinessWeek, Money Magazine, and other financial media end up making decisions that are in conflict with a previous investment decision that was made. This ends up become a vicious cycle which caused more harm that good.

    My questioning of Mr. Buffett is what the majority of the public should do in times like these. Not questioning the premise behind Mr. Buffett's most recent comments and then falling in lock step with his advice is faulty logic for several reasons.

    First, when Mr. Buffett loses 99% of his investment portfolio then he is left with, at least $43 million. Mr. Buffett will survive while the small investor who looks up to him would not be in the same position if such a loss were to occur.

    Second, following the timing of Mr. Buffett's recommendation without a background on determining what is of quality in the stock market only lead to more loses since October.

    Third, Mr. Buffett will never tell us what to buy, but somehow he does a service by telling us when to buy. I don't think so.

    Fourth, We got in this mess from following other people. Now were gonna get out of this mess by following someone else. I'm not so sure this is a responsible approach.

    Mr. Buffett, being the open book that he is, should act as a voice of caution when so many people had not heeded his warnings in the past. Mr. Buffett should retain the stance that caution is the order of the day. When Mr. Buffett suggests that 'cause he is buying then you should be buying too when he never did this before makes me concerned.

    I appreciate all that Mr. Buffett has to offer. I keep copies of his annual reports handy so that I can read them when I'm bored. However, in order for Mr. Buffett get to where he is, I'm sure that he questioned the premise of those who taught him all that he knows.

    Thanks Randfan and Mr. VS for your well reasoned responses. Touc.

  3. Touc, it speaks volumes to your character that you responded in a calm and reasoned manner to Randfan's unnecessary ad-hominem remarks, essentially ignoring them and later thanking him for his remarks.