“This time is different” - the rally cry of investors who spot an irrevocably changed market every few years - is in ample supply these days. Interest rates have reached a permanent low. US stocks have reached a permanent high. FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks will rule markets for all time. Value investing is dead.
During previous bouts, Warren Buffett, America’s patron saint of investing offered his sage — and inevitably unpopular — perspective. When the dot-com mania raged in the late 1990s, he famously warned against chasing internet stocks. And during the depths of the 2008 financial crisis, he implored investors not to give up on US stocks. Of course, neither episode turned out to be different from the innumerable ones that preceded it, at least when it comes to investing.
This time, Mr Buffett has been uncharacteristically missing from the chatter, but that doesn’t mean his views are any less clear, or any less worth paying attention to.
Let’s start with Mr Buffett’s favourite stock market barometer, the market capitalisation-to-GDP ratio. As its name suggests, it measures the total value of the stock market as a percentage of GDP. In simple terms, a lower ratio is bullish and a higher one is bearish.
The ratio was prescient during the last two downturns. It shot up to 146 per cent at the peak of the dot-com bubble in 2000, a record at the time and well above its average of 89 per cent since 1975, according to numbers compiled by the World Bank. It peaked again at 137 per cent just before the financial crisis in 2007. Where is the market cap-to-GDP ratio now? It notched a fresh high of 154 per cent in 2017, according to the latest available number, and is almost certainly higher today given that the US stock market is up roughly 7 per cent since the end of 2017.
So it’s probably safe to say that Mr Buffett doesn’t love the lofty level of the stock market. And judging by the record $122 billion (Dh448bn) of cash he’s hoarding at Berkshire Hathaway, it’s also safe to assume he doesn’t expect the market to remain elevated forever. Mr Buffett’s cash pile is more than half the value of Berkshire’s $208bn portfolio of public companies, and since 1987 his cash allocation as a percentage of Berkshire’s portfolio was only higher in the years leading up to the financial crisis.
At the same time, the few stocks that do appeal to Mr Buffett suggest his faith in value investing is unshaken despite a miserable decade of underperformance for the strategy. Roughly 45 per cent of Berkshire’s stock portfolio is allocated to the financial sector, and eight of the portfolio’s top 12 holdings are financial stocks — a deeply contrarian bet. The sector has been hampered for much of the last decade by tighter regulation and low interest rates. While profits have picked up recently, many investors fear that a prolonged period of low rates will keep a lid on profits for the foreseeable future.
As a result, the financial sector has been one of the cheapest sectors by most measures for years. It’s still the most represented sector in many value indexes, including a 21 per cent allocation in the S&P 500 Value Index and 23 per cent in the Russell 1000 Value Index. That’s apparently not enough for Mr Buffett, whose allocation to the sector is double that.
Much has been made of Mr Buffett’s uncharacteristic pivot to technology stocks in recent years, but that, too, is mostly a value play. Apple makes up nearly 90 per cent of Berkshire’s 27 per cent allocation to the technology sector. When Mr Buffett began buying Apple in early 2016, it was a bona fide value stock. It boasted an average price-to-earnings ratio of just 10.6, based on 12-month trailing earnings per share, and an average price-to-cash flow ratio of 7.5 during the first quarter of that year, well below the S&P 500’s P/E ratio of 19.5 and P/CF ratio of 10.9. Apple is pricier today, but it’s still the largest name in the S&P 500 Value Index, with a hefty 8.3 per cent allocation.
Mr Buffett has said that he regrets passing on Amazon.com and Google parent Alphabet when the companies were younger, but don’t mistake the maestro. The fact that he isn’t loading up on them today, despite having plenty of cash to do so, speaks volumes. Amazon trades at a jaw-dropping P/E ratio of 73 and Alphabet at 27, which is the furthest thing from value. Mr Buffett already has a small 0.5 per cent allocation to Amazon on the recommendation of one of his deputies. Don’t count on him making meaningfully more room for Amazon or Google at current prices.
For now, Mr Buffett is paying a price for his dissent. Berkshire’s return trailed the S&P 500 by 0.9 percentage points a year from 2009 to 2018, including dividends. It’s not the first time. Mr Buffett lagged the market by 3.2 percentage points a year around the Nifty Fifty craze from 1971 to 1975 and by 6.1 percentage points a year during the dot-com boom from 1995 to 1999.
Still, Berkshire’s portfolio remains unabashedly Buffett: big profits at a reasonable cost. The portfolio has a weighted-average return on capital of 12 per cent, compared with just 7.9 per cent for the S&P 500. And it’s far cheaper. Mr Buffett’s portfolio has a P/E ratio of 16.5, based on 12-month trailing operating earnings per share, compared with 21 for the S&P 500.
There’s little indication, in other words, that Mr Buffett is wavering from his long-standing investing principles. It’s a timely example, even if Mr Buffett is no longer eager to say so.
Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.
Bloomberg
