What Early Buffett Did In A High Market (And What You Can Learn From It)

The nitty-gritty

Before I get into nitty-gritty I would just like to state this is not article about an economic prediction or market prediction. I simply just want to point out the facts. As Charlie Munger put it ‘‘We’re not predicting the current that will come, just how some things will swim in the currents, whatever they are’’.

It’s no secret that the market is expensive. Currently the S&P 500 is trading at a P/E of 30. For a historical context in September of 2000 the S&P 500 traded at a P/E of 25.6. For the next 11 years the S&P 500 delivered zero returns inclusive of reinvested dividends. History does not repeat itself, but it does rhyme. Keep in mind that the long-term average P/E of the S&P 500 is 16x

One of my favourite speeches of Warren Buffett is his speech he did at a conference in 1999. At the very high of the tech bubble, he gave a very unpopular warning to the top tech CEOs of the time. In short Buffett acknowledged performance of the market in recent years. But this should make investors cautious. Over time, he warned, reality would catch up to lofty valuations. Buffett continued in his speech and he basically said there were only three ways the stock market could keep rising at ten percent or more a year. One was if interest rates fell and remained below historic levels. The second was if the share of the economy that went to investors, as opposed to employees and government and other things rose above its already historically high level. Or he said the economy could start growing faster than normal. He called it ‘‘wishful thinking’’ to use optimistic assumptions like these. My prediction is if Buffett did a speech today he would probably be saying the exact same things as he did back in 1999.

Looking to the U.S.A markets its hard to find anything, most have to look to Canada or Europe to find value discrepancy. Kering is cheap though same with Booze stocks. However, those stocks still trade high compared to what I’m looking for. I’m looking for classic low P/NCAV type investments. A deeply discounted stocks trading near or under liquidation value with inevitable business models. Recently I have been diving deep into OTC markets stocks. Going A-Z and still I have not had much luck. However, I’m still looking. Recently I’ve been feeling like a womanizer on an uninhabited island. So the question is what to invest in when the market is very high? Well let’s look to the old Buffett Partnership letters to find an answer.

Buffett Partnership

Before getting into what Buffett did in rising markets I think its best to start off with information about the Buffett Partnership.

A whopping +25.3% after fees CAGR is God like. But how did he achieve this? The Buffett Partnerships had 3 buckets of investments. If you’re interested in good books on the early partnership days, I would recommend ‘‘Warren Buffett’s Ground Rules’’ by Jeremy Miller and ‘‘Buffett’s Early Investments’’ by Brett Gardner.

Generals – Undervalued stocks, ‘‘net nets’’ low P/NCAV. Bought very cheap and held until the market recognized their value.

Workouts – Special situations like mergers, liquidations, or restructurings where a catalyst would unlock value in a short period.

Controls – Companies where Buffett took a large stake to influence management and operations, aiming for long-term value creation.

The Nitty-Gritty

Now that we have a summary of the Buffett Partnership we can carry onto the main topic of this article. What early Buffett did in a high market and how us as investors can learn from him.

‘‘The higher the level of the market, the fewer the undervalued securities and I am finding some difficulty in securing an adequate number of attractive investments. I would prefer to increase the percentage of our assets in work-outs, but these are very difficult to find on the right terms’’ - Buffett Partnership letter 1958

‘‘If the general market were to return to an undervalued status, our capital might be employed exclusively in general issues and perhaps some borrowed money would be used in this operation at that time. Conversely, if the market should go considerably higher, our policy will be to reduce our general issues as profits present themselves and increase the work-out portfolio’’ - Buffett Partnership letter 1957

In short Buffett is saying that he tilts the portfolio mix towards generals when the market is falling and tilt towards workouts when the market is rising.

To be honest, I have very little experience and knowledge on how to analyse workouts. I have spent the vast majority of my time as an investor looking at Generals. However, I have recently ordered on Amazon the first edition of Benjamin Grahams and David Dodds ‘‘Security Analysis’’. Although I have read the seventh edition of Security Analysis, apparently the first edition goes into more detail about workouts. Furthermore, I have also ordered ‘‘Investors Guide To Special Situations’’ by the father of special situations Maurece Schiller. I will also be re-reading Joel Greenblatt class notes and his book ‘‘You Can Be A Stock Market Genuis’’. Although the title isn’t the best it truly is a great book about workout type investments. In the future I want to post a mix of General and Workout ideas here.

A Workout Idea

Although I have very little experience and knowledge on workouts and my goal is to grow my knowledge base on the subject I have in the last couple of months kept my eye on one workout. Here’s the short thesis. DallasNews Corporation (DALN) expect to close the sale of its property soon and when that happens shareholders are expected to get a special dividend of $3 – $5 in the next few months. Since the stock is currently sitting at $6.59 a $3 special dividend would be 45.5% of its current price. However, this is assuming the sale closes.

Disclaimer: The information provided in this article is for educational and informational purposes only. It does not constitute financial advice, investment recommendations, or an offer to buy or sell any securities. You should conduct your own research and consult with a qualified financial advisor before making any investment decisions. The author may hold positions in the companies mentioned, but the opinions expressed are their own and are subject to change without notice. Investing involves risk, and past performance is not indicative of future results.