Analysts Perplexed by Prudence

The End
October 29, 2019

During my typical daily intake of financial news, I came across an article on CNBC.com with the title “Warren Buffet has $128 billion in cash to burn and analysts can’t figure out why he isn’t spending it.”

As I read the article, I could not help but feel like I was reading something produced by the satirical news outlet The Onion. I felt that the alternate title “Analysts Perplexed by Prudence” would have been just as applicable. Believing that the ultimate outcome of this symptom will be less than humorous for many, the more appropriate alternate title is probably “Wall Street has a short memory, if any at all.”

To understand what follows, one will want to take a peek at the CNBC article, or, at least, accept that the actual title is a concise but accurate summary. It will also be fairly important to understand that Warren Buffet is Chairman and CEO of a company called Berkshire Hathaway, and is widely accepted as one of the most successful investors of our time. Just in case additional evidence is required for his investing prowess, he also happens to be one of the wealthiest people on the planet…ever.

At the moment, Buffet is being given a hard time by many because he has accumulated a large cash position. As the article makes clear, “analysts can’t figure out why he isn’t spending it.” Specifically, from this article and others I’ve recently seen of the same tenor, many analysts and professional investors cannot seem to figure out why one of the most successful investors of all time is not buying back shares in his own company or buying the shares of other companies with this huge pile of cash.

What reason might someone whose success depends on the capital appreciation of assets purchased have for opting to hold cash as opposed to spending it on new assets or concentrating their exposure to currently owned assets by purchasing shares in their own company?

This isn’t the first time that Buffet’s apparent clairvoyance has been questioned. Back at the turn of the century, it appeared as if Warren had truly lost his touch, and analysts just couldn’t understand why he wasn’t doing what everyone else was doing. The opening line from this article by Barron’s back in 1999 was “After more than 30 years of unrivaled investment success, Warren Buffet may be losing his magic touch.”  

To be sure, around that time, it certainly appeared that Buffet was on his way out. From the beginning of 1999 to March 10, 2000, while everyone else with a pulse was printing money for themselves in high flying growth stocks – demonstrated by the NASDAQ Composite Index’s meteoric 128.65% increase over that period – silly old Warren’s Berkshire shares had decreased in value by 41%.

Unfortunately, for everyone else with a pulse, from March 10, 2000 to October 9, 2002, the NASDAQ Composite Index went on to lose 77.93% of its value. As for silly old, lost the magic Warren, his Berkshire shares increased in value by 64.89% over that same period. In other words, had $100,000 been invested in the NASDAQ Composite Index (if that were possible) on March 10, 2000, when it seemed unreasonable that anybody would be doing anything else, that initial investment would have been worth $22,070 on October 9, 2002. On the other hand, the same investment over the same time period in Berkshire would have grown to $164,890.

Interestingly, if that same investment made on March 10, 2000 had been held until November 1, 2019, the value of the NASDAQ allocation would have grown to $166,110 while the value of the Berkshire allocation would have grown to $783,050. Not a terrible excess return for someone who has lost their touch.

I do not write this article as an endorsement of Warren Buffet or Berkshire, but to point out that, in a world gone mad, sanity can look a lot like lunacy. That is, right up until it doesn’t, of course.

So, what reason might someone whose success depends on the capital appreciation of assets purchased have for opting to hold cash as opposed to spending it on new assets or concentrating their exposure to currently owned assets by purchasing shares in their own company? Perhaps that person believes that the new assets available for purchase are presently too expensive to generate the desired long-term capital appreciation. Or, perhaps, that person believes that the cash currently held may be utilized to purchase assets desired today at a cheaper price at some point in the future. In a similar vein, this person might be satisfied to forego the potential short-term earnings per share sugar rush produced by buying back their own shares today in an effort to produce real value by buying back shares when they aren’t so close to the most expensive that they’ve ever been, or, again, waiting for the same to be true of assets not currently owned.

Many professional investors, non-professional investors, and analysts like to convince themselves that they are investors for the long-term. In reality, most people are only ever looking at very recent past performance and projecting that into the very near future. Sadly, this is rational to some extent. Individual investors do not like to underperform over any time period and especially do not like to underperform over multiple time periods – even if those periods are as brief as quarters of a year. The professionals that answer to these investors want to remain employed, and, therefore, need to adapt their focused time period to that of their clients. The problem is that, to hold one’s face so close to a map as to only see the last one hundred feet traveled and the one hundred feet ahead is a poor method to navigate a 3,000 mile journey.  

Maybe Warren really has lost his touch this time. Maybe he still doesn’t care about what everyone else with a pulse seems to be doing and is just applying the common sense he has developed to his view of the map. Maybe analysts wouldn’t be so confused if they dropped the presupposition that every rational investor believes that the market will never be cheaper than it is today.  

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