Given the turmoil the financial world is in, one wonders if the Warren Buffett approach to investing will work as well as in the past.
In fact, it hasn’t really worked for Buffett himself, never mind his iconic status as America’s best-known investor. This year, Buffett has broken all his old rules. Among them: that he won’t buy tech stocks (he bought IBM shares recently), and that he will not buy back his own Berkshire Hathaway shares (he swallowed his pride and did that as well) to improve share prices.
Around end-September, the Berkshire board announced that it would buy back its shares at any price below 1.1 times its book value (assets minus liabilities) — without committing to actually do so. In announcing a buyback, he has reversed his own statement made on 26 February, when he told shareholders that “Not a dime of cash” had been spent on dividends or buybacks, says a Bloomberg report .
The 1.1 times book value benchmark is a dead giveaway. What it means is that investors are less willing to buy his shares even at prices marginally above book, when the S&P 500— the broad index of equity in America — is quoting at twice its book value. (The Sensex is currently at 2.2 times its book value ).
Put another way, investors are valuing the broad indices higher than the market’s most celebrated investor.
Little wonder canny investors are bailing out of Berkshire Hathaway, and even boasting about it. In a recent blog at Barron’s titled “Why I sold Berkshire Hathaway,” investor Doug Kass is quoted as saying: “I worship at the altar of Warren Buffett” but “Berkshire’s past growth and successes are one of its greatest enemies to future growth. Ever-larger investments/acquisitions are required to produce an impact and provide differentiated returns for shareholders.”
The translation is this: Berkshire’s best days are over. Buffett is so yesterday.
Followers of Buffettology in India are not exactly keeping their faith either. Take the case of Rakesh Jhunjhunwala – often considered the desi Buffett, with his penchant for buying big chunks of shares in promising companies and holding on to them for long periods of time.
Jhunjhunwala has two sides to him. He is not only a buy-and-hold guy like Buffett, but also plays the market and makes speculative trading bets to skim the cream. In short, one part of his portfolio is long-term, where he looks for returns in the range of 18-24 percent. The other part is purely opportunistic.
In recent weeks, he apparently got his speculative bets all wrong, according to The Economic Times. The newspaper speculates that Jhunjhunwala had placed huge bets in silver futures and the Nifty, but the bets went wrong, forcing him to sell his long-term portfolio.
“I never talk about my trading bets”, the newspaper quoted him as saying. But in a CNBC-TV 18 interview last Diwali, he was candid enough to admit that he got all his stock calls right, but all his trading calls wrong.
The digression about Jhunjhunwala is to make a broader point: after you grow to a certain size, you can’t follow the straight-and-narrow path of stock fundamentals and cash flows to get spectacular returns.
In Buffett’s case, the fact is Berkshire Hathaway is too big to deliver the kind of returns it did in the past. When you are a $100 million company, you can grow in leaps and bounds. When you are a $190 billion one, you can’t grow at that rate.
Says Kass in the Barron’s blog: “The $10 billion investment in IBM is, to this observer, a reflection that larger deals are needed to move the needle and that more ordinary and plain vanilla investments will be the feature of Berkshire’s portfolio strategy in the future.”
However, there is a deeper reason why Buffett is unlikely to perform as well as he did in the past: the world has changed. In particular, value is no longer created by companies as steadily as they did in the more predictable past.
The core of Buffett’s investment philosophy is this: buy companies with steady and high cash flows at a price that is below their intrinsic worth. Of course, that they must also have good brand value and solid management are a given. When free cash flows are good, an ever-expanding investor class ensures that stock prices were largely on an upward trajectory.
But hyper competition (the rise of China and India), the levelling of the playing field by web and communications technology, and the growing financialisation of the world have changed the rules of the game completely.
The key to Buffett’s dream run over the last three decades was liquidity. It is liquidity – a growing pool of investors and investment funds – that keeps markets and share prices rising. This is no longer the case in the west – but may be truer of the emerging markets, where growth is higher (but uneven) and where stocks are still not the preferred form of savings.
It is in places like India and Brazil that you will find an ever-growing pool of financial savings moving into stocks – and driving the markets higher. Buffett is stuck in America, when his real gains will come from here.
Corporate cash flows and profits are no longer predictable in a world where technologies and business models have risen and fallen suddenly and abruptly: from GE to Citicorp, giants of yesteryear have fallen from grace. The big winners of the digital age are the Apples and Amazons of the world, not the regular brick-and-mortar brands that Buffett has favoured so far. But even they are vulnerable to the Samsungs of the world.
Winning in the brave new world of “Revolutionary Wealth” – the title of a book by Alvin and Heidi Toffler – needs investors to not only look at the Buffett cash flow benchmarks, but also more closely at what competition is doing to companies, industries and stock values. Stock wealth is today created astonishingly fast – and also destroyed equally fast.
Countries are also rising and failing astonishingly fast.
In the 21st century, we need a Buffett Plus nimble investment strategy. Buffett’s static concepts of the second half of the 20th century will have to be rewritten.