Will the Real Mr. Buffett Please Stand Up!

As an investor who has to take responsibility for my actions, I seek out as much information as I can. Although I am willing to take in as much information as possible, I attempt to discern quality from the junk, critically analyze the information and questioning my assumption along with the author that I’m reading. For this reason it did not go unnoticed when I read the October 16, 2008 New York Times op-ed piece written by Warren Buffett titled “Buy American. I Am.”

It turns out that in my zeal for seeking quality information, I found that Mr. Buffett had written an article in Fortune Magazine back in May of 1977 titled “How Inflation Swindles The Equity Investor.” If you didn’t know who the author was you’d probably think that the articles were written by two entirely different people.

In the article “How Inflation Swindles The Equity Investor,” Warren Buffett states in significant detail many reasons why and how inflation is the bane of equity investors. One such reason is that in order for companies to get through an inflationary period they are forced to issue new shares to service liabilities that had been accrued in prior years. This method of dealing with inflation was used to offset the payment of dividends.

In essence, a company would pay a dividend “…of $3.3 billion and asked investors to return $3.4 billion” (in the issuance of new stock). According to Mr. Buffett, the act of paying dividends and then issuing new stock exceeding the value dividend payments is among the problems that are part of the equity swindle. It should be known that Mr. Buffett’s article was extensive and left no doubt about the impact that inflation has on corporations.

Fast forward 31 years later, Mr. Buffett writes a concise op-ed piece in the New York Times titled “Buy American. I Am.” Published in the throes of a banking crisis, Mr. Buffett’s words were intended to provide assurance to a public that couldn’t trust either the banks, the government or regulators assigned to ensure stability in the financial system. Mr. Buffett points out that government policy to deal with the financial crisis “…will probably prove inflationary and therefore accelerate declines in the real value of cash…” Mr. Buffett goes on to suggest that individuals would be wise to invest in stocks.

I begin to wonder how an investor is supposed to make sense of the two articles. In the one case, Mr. Buffett offers an elaborate explanation for why equity investors are getting "swindled" during inflationary periods. In the other case, Mr. Buffett suggests that over the next ten years stocks will beat cash in a high inflation environment.

Is the only distinction that Mr. Buffett is making is the comparison between cash and stocks during inflation? If this is the case then we have to wonder which is the bigger swindle, cash that is being debased or stocks, where the management of a company can arbitrarily increase the number of shares denominated in a debased currency.

As far as I can tell, the last several months have had the largest increase in the issuance of secondary offerings (new stock) from major corporations. You'd think that Mr. Buffett would be speaking out about this based on his writings from the 1970's. I believe that I know which of the two articles is correct however, what is a person supposed to think when they hear the most successful investor in the world seemingly speak out of both sides of his mouth? I'm guessing that Mr. Buffett isn't expecting us to remember what he said 31 years ago.

“A patriot wraps himself around the flag to defend it; a scoundrel wraps it around himself to defend himself”

Sources:
  • Ellis, Charles. Classics: An Investor's Anthology. The Institute of Chartered Financial Analysts. 1989. p. 483.
  • Buffett, Warren. "Buy American. I Am." New York Times. October 16, 2008. accessed online August 21, 2009.

One response to “Will the Real Mr. Buffett Please Stand Up!

  1. "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.