Bogle & Buffett on Stocks

John Bogle and Warren Buffett and made some rather noteworthy comments about stocks last month.

More on their comments below. First, here's a quick look at the GMO 7-Year Annual Real Return Forecast for stocks:

U.S. Large: minus 2.0%
U.S. Small: minus 3.8%
U.S. High Quality: 3.3%
Intl Large: 1.9%
Intl Small: 1.6%
Emerging: 6.5%
(GMO also provides forecasts for other asset classes that I've not included here)

Now I don't usually find most forecasts to be all that useful but, at a minimum, this probably should give someone pause who has very high expectations of future equity market returns.

Keep in mind that GMO's forecast was made when the stock market was lower than it is now.

For some context, here's an article that summarizes how past GMO forecasts (going back to 1994) have looked against reality over the years.

"While there was clearly a pessimistic bias to the forecasts, the direction of their guesses was remarkably accurate..."

The reason I don't pay much attention to forecasts is simply because, in the long run, what the market as a whole does matters far less* than whether a specific investment's intrinsic value has be judged well, and whether a nice discount was paid to that estimated value.
(I've said before: A well-judged long-term investment that temporarily gets an even bigger discount due to market conditions shouldn't be a problem. It's just an opportunity to accumulate more while making buybacks, if they already made sense, even more effective.)

John Bogle recently offered his own slightly more optimistic and straightforward view.

He said that at "a 2% dividend yield, which is roughly where we are today, and possibly--maybe a little optimistically--5% earnings growth from here; that would be a 7% what I'll call investment return, a fundamental return--the real return, not real in the inflation sense, but the actual return earned by Corporate America. And that looks to be around 7%; it could be point or two more.

I don't look for speculative return, which is will that P/E go way up or way down. I can't imagine it going way up. I think it is unlikely it will go way down."

He continued by saying...

"7% is pretty good. You double your money in a decade. Think about this for a minute: That's not a very high real return. By the time this decade over, we'll probably be around a 2% inflation rate, if we are lucky. Maybe all hell is going to break lose, with all this purchasing by the Fed of the securities. But [assuming 2% inflation], that would be a 5% real return, and that's about a point lower than the long-term norm."

There's no getting around the fact that stocks are up quite a bit in a relatively short amount of time. Anytime prices start to move up quickly, there's an increasingly high probability that the margin of safety on many investments is beginning to disappear, has disappeared completely, or worse yet, is plainly overvalued.

To me, that's the time to start being more cautious unless a specific investment one happens to understand well has remained cheap.

This unattractive near-term environment might seem at odds with the following comment by Buffett in an interview last month on CNBC:

"The stock market compared to most assets, all of the big asset classes in my view, is the most attractive place to have your money over the next 20 years; whether it's over the next 20 days or 20 weeks I don't know but..we have our money in businesses. We own all of some businesses, we own parts of some businesses and we call those stocks -- and that's where we think value lies."

To me, it really is not at odds. Sometimes a fine business just happens to not fit in with whatever is hot at the moment; for whatever reason it just doesn't capture the speculative imagination.

Sometimes a fine business has near or intermediate term real, even serious, but fixable business challenges.

These can be opportunities for those who are more interested in long-term outcomes and less concerned with near term price action.

Even very good businesses run into difficulties from time to time. Well, market participants who chase the near-term price action are naturally not going to have patience for such things. They'll likely head for the exits at the first sign of real trouble.

In other words, they're mostly interested in profiting from price action and less focused on increases to long run per share intrinsic business value. For these participants, increases to per share intrinsic value are, at most, a secondary consideration. The idea of patiently waiting for challenges to be sorted out -- and, if they do, profiting much later -- just doesn't fit in with the ethos.

What stocks might do in the near term might be of interest to speculators, but Buffett and Bogle are talking strictly about changes to per share intrinsic business value over longer time frames.

Investment returns instead of speculative returns.

Share prices may fluctuate wildly near term but, in the long run, they're going to roughly reflect changes to per share intrinsic value.

Buffett doesn't think there currently is a bubble in stocks. When asked if stocks were at bubble levels he also added:

"...we could at some point, but no, stocks are not selling at bubble levels. What do you diversify in? Do you want to diversify into cash? I think it's a terrible investment compared to equities. Do you want to diversify into long-term bonds? I think it's a terrible investment compared to equities. So...I're going to have your assets in something, and I think that good businesses held for a long period of time are certain to deliver good results."

Certain individual securities may remain attractive, but that doesn't necessarily mean the market as a whole is particularly attractive.

It also doesn't mean it's in bubble territory even if certain stocks seem to surely be getting there.

In any case, the risks of buying whatever the hot money is chasing seem undeniable (even if the risks don't become obvious until much later). In fact, many individual stocks seem extremely overvalued. Okay, maybe not late 1990s overvalued**, but actually some individual high flyers aren't far from it.

Buying with a nice margin of safety is central to the investment process. With that in mind, the time to be buying was when huge discounts to per share intrinsic value existed. Several years ago -- during and coming out of the financial crisis -- was as good an example as any of an opportunity to do just that sort of thing.

That opportunity is mostly in the rear-view mirror. This probably seems obvious now, but investment success requires decisive action when it doesn't feel particularly good, and knowing what you want to own (with a high conviction level).

Buffett's emphasis is always on the long-term. That's not exactly news. It's just that investing is never about what the price action might be in the near term or even intermediate term. It's certainly not about market timing. Somehow, this sometimes still seems to get missed. It's a focus on how price compares to the per share intrinsic value of a business that's truly well understood (in contrast to an investor who overestimates how well something is understood). It's coming up with conservative estimates of value. It's ignoring short term market noise. It's being prepared to buy when uncertainty seems at its greatest (or very near to it).

Now, I'm certainly not always reluctant to buy stocks. Prior posts during what appeared to be more uncertain times over the past five years or so should make that pretty obvious. I say "appeared" because the world is always uncertain (it's just the perception of uncertainty that changes). Adverse and unpredictable events are inevitably always ahead. From a long-term equity investor point of view, the best times to buy are usually when the headlines are the most daunting.

That's when stocks are likely to be most attractive to invest in for the long-term.

That's when the margin of safety is generally largest even if buying doesn't feel good at the time. Temporary paper losses are almost a certainty. What's cheap becomes cheaper. Attempting to always buy something that's plainly undervalued without suffering temporary losses creates a very different risk: owning far fewer shares (or even none) compared to the quantity that was wanted of a well understood business. There's only so many investments one can know well. Missing the chance to own, for the long haul, a meaningful quantity of what one knows at an attractive price makes little sense.

Buffett's view might seem to contradict GMO's view greatly but really doesn't. That the market as a whole isn't likely to do particularly well in the coming years (as always I never have a view on the markets) doesn't mean shares of an individual business aren't selling at a nice discount to value.

The latest Berkshire Hathaway (BRKa) results revealed that Buffett did slightly more buying than selling of equities in the third quarter:***

Of course, you can't read too much into how much has been bought or sold in any given quarter.

Yet he seems inclined to be buying more so than selling if you look at the first nine months of this year (especially when the Heinz acquisition is included).

The same has been true, by and large, during and since the financial crisis began.

It's not timing the market. It's comparing price to per share intrinsic value and paying a nice discount for something that's understandable.

Even if, at times (like the late 1990s, for example), it becomes generally difficult to find attractively priced equities, the emphasis isn't on timing.

The emphasis is price versus value.


Long position in BRKb established at much lower than recent market prices

* Though those biased in favor of efficient markets surely won't agree.
** In contrast to now, Buffett was warning that many stocks were quite overvalued in the late 1990s.
*** Subtract purchases and sales of equity securities in the current (page 5) Consolidated Statement of Cash Flows from the prior purchases and sales of equity securities.
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Bogle & Buffett on Stocks
Bogle & Buffett on Stocks
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