A bubble warning from Warren Buffett

Warren Buffett's warning and advice on bubbles.

Buffett's and Shiller's stock valuation methods agree

Carol Loomis of Fortune has a new article out saying that Warren Buffett's valuation metric says it's time to buy stocks. I decided to compare Warren Buffett's stock valuation metric with Robert Shiller's. They both compare nicely.

Warren Buffett's stock valuation metric: Total stock market value as a percent of GNP.

Yale economist Robert Shiller's stock valuation metric, based on Benjamin Graham's advice in Security Analysis: S&P 500 10-year price/earnings ratios.

Robert Shiller doesn't compare the S&P 500 only to its current year earnings. Instead, he compares it to the average of the past ten years, adjusted for inflation. This way, he avoids getting fooled when single-year corporate earnings rise and fall with the business cycle.

Although Warren Buffett's and Robert Shiller's valuation methods are entirely different, they both seem to track each other fairly nicely. Knowing what happened in 1929, however, it looks like Robert Shiller's valuation method is slightly better than Warren Buffett's.

Buffett stocks on sale

Warren Buffett is widely regarded as the world's greatest investor. His basic strategy is to buy great companies at low prices, and then hold them forever. Many investors try to emulate Buffett's investing method when making their own stock picks, but few can match Buffett's success.

However, one investing strategy available to ordinary investors is buying stocks that Buffett actually owns, when they fall below his original purchase price. Luckily, he lists his major holdings in Berkshire Hathaway's annual letter to shareholders. With a little basic math, you can figure out how much he paid for the stocks he bought.

Today, with the recent stock market sell-off, many of Buffett's holdings are selling for less than what he paid for them. This gives you the opportunity to buy them on sale. I have calculated the purchase price for his major holdings. Here are the ones that are currently on sale.

Stocks currently selling below Buffett's purchase price, and the price Buffett paid:

• ConocoPhillips (COP) — $59.34
• Kraft Foods (KFT) — $33.38
• Procter & Gamble (PG) — $61.14
• Sanofi Aventis (SNY) — $43.21
• US Bancorp (USB) — $32.80
• USG Corporation (USG) — $31.40
• Wells Fargo (WFC) — $34.96

Stocks currently selling slightly above Buffett's purchase price, and the price Buffett paid:

• Burlington Northern Santa Fe (BNI) — $77.78
• Johnson & Johnson (JNJ) — $61.35
• Wal-Mart Stores (WMT) — $47.23

Although this second group is slightly above his purchase price, a single down day in the stock market could push some of them below his purchase price.

Honestly, I don't know what he's doing owning USG. It's a no-growth company, paying no dividends, tied to the housing market. The others, however, would likely serve you well.

Update 10/30/2008: Berkshire has bought more BNI at $79.65 per share.

Warren Buffett says buy stocks now

Warren Buffett, the world's greatest investor, has a message for people who have become fearful of today's stock market: Buy stocks now!

I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over. ...

Over the long term, the stock market news will be good. ... Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset.... Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. ... Today my money and my mouth both say equities.

Warren Buffett wisdom

Stock market thoughts from the Sage of Omaha:

You know, five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well.

Buffett suggests improvement to TARP

From Fortune Magazine:

Warren Buffett suggested Thursday that the U.S. Treasury team with private investors to buy the distressed mortgage assets at the center of the controversial $700 billion Wall Street bailout, and said the price tag of the rescue plan may have to rise.

Buffett, the chairman and CEO of Berkshire Hathaway, called the problems facing world markets "unprecedented" and warned of a "disaster" if Congress does not move faster to shore up the economy.

"We had an economic Pearl Harbor hit," he said ... "For a couple of weeks we've been arguing about who's at fault [and] fooling around while things have gotten a lot worse." ...

"It will cost more to solve this problem today than it did two weeks ago," said Buffett...

But he described a plan he thought of Thursday morning on the way to the Summit that would allow Treasury and private investors to buy assets together. He said his proposal would kickstart demand for mortgage-backed securities, help find a market price for these troubled assets and make it more likely that taxpayers would be made whole or even come out ahead in the bailout.

Under Buffett's plan, Treasury would lend hedge funds, Wall Street firms or any other investors 80% of the price for distressed assets. Investors would benefit from borrowing at lower rates available to the Treasury. But the government would get first claim on the sale of those assets, which means it would get its loan back plus interest and possibly turn a profit. Only then would investors see a penny.

"Now you have someone with 20% skin in the game," explained Buffett. "Believe me, I won't be overpaying if I'm buying with that kind of leverage. And you have someone [the investors] to manage the assets to the extent they need to be managed."

Buffett also noted that the presence of the government in the transactions would raise the price of assets above the absolute firesale levels for which they could now be sold. That would benefit the banks trying to unload them. ...

He said the [financial] problem boils down to widely-held assumption during the housing boom that prices could only go up.

Under this scenario, the private investors would benefit by being able to borrow at ultra-low interest rates that normally only the government can get. They could also get higher potential returns by having higher leverage. Meanwhile, taxpayers are protected because the private investors would take a 100% loss before the government lost a penny. This gives the private investors a very strong incentive to protect taxpayers from a loss.

Buffett warned Congress of "biggest financial meltdown"

Buffett urged Congress to pass the Troubled Asset Relief Program:

Legendary investor Warren Buffett warned Congressional leaders Saturday night of "the biggest financial meltdown in American history" if they did not act to secure the financial system.

Buffett, by telephone, was consulted by lawmakers who were in marathon talks on Capitol Hill to forge a deal on the administration's $700 billion economic bailout plan, according to two sources.

One lawmaker in the negotiations said that the participants called Warren Buffett to get his help in gauging potential market reaction. ...

Earlier in the week, Buffett also warned that the financial crisis is "everybody's problem," not just Wall Street's. The potential collapse of financial institutions would cause industry to grind to a halt, he told CNBC Wednesday, and could have "gummed up the economy."

Prediction: Buffett Will be Asked to Manage Bailout

Assuming this bailout (Troubled Asset Relief Program) becomes law, I predict Warren Buffett will be asked to run it, pro bono.* With $700 billion of American taxpayer money at stake, politicians will have an exceptionally strong incentive to recruit the absolute best person for the job. Warren Buffett is the obvious guy to pick. Also, this is the year that both presidential candidates are advocating national service—putting country before self. Asking the world's greatest investor to put country before self isn't too much of a stretch.

I estimate the probability that Buffett will be asked to do it is less than 50%, but far higher for him than for any other individual alive.

Here's Vince Farrell's take on CNBC:

Buffett is smarter than I am. He's probably smarter than a lot of other people as well. ...

I did love his comment that he wished he had $700 billion to buy the derivatives with. Maybe we should ask him to do it! And I'm not kidding!

And here's billionaire T. Boone Pickens, interviewed by CNN:

Roberts: In fact, you have said, Boone, that you would like to see Warren Buffett handle a lot of these illiquid assets that the government buys up in terms of their disbursement.

Pickens: Can you imagine anybody better? Sure, that'd be great if he'd do it. I don't know whether he would or not. But you need to get somebody like Warren to do it.

Roberts: You don't think they have the expertise at the Treasury Department to do it?

Pickens: Oh, they do have. They may need some help. And that kind of help — you can't pay for that kind of help.

If Buffett doesn't do it, billionaire "bond king" Bill Gross has volunteered to do it for free.

* For the world's second richest man, a typical government salary is essentially pro bono.

Buffett Supports Bailout; Says Gov't Will Make Money

In a long interview uninterrupted by commercials on CNBC this morning, Warren Buffett voiced his support for Treasury Secretary Paulson's proposed bailout. He also said the U.S. government will make a very good profit on the deal (15%+ rate of return), if it buys at market prices.

Fed Chairman Ben Bernanke stupidly suggested yesterday that the government should buy at significantly above market prices. Buffett said that is not a good idea.

Buffett didn't mention this, but I should point out that if the government follows Bernanke's stupid idea and pays above market prices, it would remove less bad debt off of bank balance sheets than if it paid market prices. (The higher the price, the less you can buy.) Bernanke needs a refresher course in microeconomics, since he's suggesting paying more than the equilibrium price.

Buffett also said that President Obama or President McCain should keep Hank Paulson as Treasury Secretary for the first year of their presidency. (I think Obama could probably do quite well with NJ Governor Jon Corzine as Treasury Secretary, if he wanted. Jon Corzine, a Democrat, was Paulson's predecessor as CEO of Goldman Sachs.)

Here is the full interview:

• Part 1
• Part 2
• Part 3
  

While on the topic of the bailout, let me point out that Carnegie Mellon University economist Allan Meltzer has his own proposal:

if they're going to do something, then what they ought to do is make loans, which the financial institutions have to repay with interest. And if you think — that's an idea which the Chileans have used in a bigger crisis than this for them in 1982, and it worked for them. People paid back the loans. They weren't allowed to pay dividends until they repaid the loans. They weren't allowed to take bonuses until they repaid the loans. I think that's the way — if we're going to do this, then that's the way we should do it.

Somehow, I doubt that if the government follows Meltzer's idea it will earn a 15%+ rate of return. However, I do like the idea of prohibiting dividend payments until the credit crisis has passed.

Warren Buffett on Housing: "We had a very, very big bubble."

Warren Buffett, the world's richest man and world's greatest investor, did three hours of interviews on CNBC this morning. He covered a number of topics, including housing. A few nuggets from the CNBC summary that may be of interest to readers of this blog:

6:48 AM: Is Fannie Mae going under? Buffett says in a sense they already have because they wouldn't survive without government backing. "They priced risk wrong."

7:03 AM: Becky asks again about the economy and he repeats his view that the negative ripples will continue to spread for awhile. He sees no "early end" to the problems although they will end eventually.

7:10 AM: Asked about the oil market, Buffett says demand and supply for crude has changed significantly in the past five years. He thinks Boone Picken's energy plan is "on the right track" and warns that the world cannot keep increasing its demand for oil.

7:38 AM: [Becky] asks what grade he would give to the Federal Reserve. He says he admires anyone who takes on a very difficult job. He might not always agree with Fed Chairman Ben Bernanke but he admires that Bernanke is taking tough problems with no obvious answers.

7:40 AM: Buffett says there's a "reasonable chance" that Fannie and Freddie's equity will be wiped out. They keep existing because they're backed by the government, and the government should continue to support them, except for the equity portion. He notes that Berkshire had been a big holder of the GSEs before selling the entire stake around 2000 and 2001.

7:42 AM: Buffett says he has no bets against the U.S. dollar right now and no direct currency plays. He also notes that stocks are generally more attractive now than they were a year ago.

7:53 AM: Buffett: The Fed "has real problems on inflation." ... Wholesale prices will "have to" show up in consumer prices. Once inflation is "ignited" it gets difficult to bring it under control.

8:01 AM: Are there bargains in the stock market? Buffett says yes, there are companies that are better today than they were a year ago selling for lower prices. When he gets calls from someone who has just lost billion of dollars and wants to be replenished, he doesn't get that excited. He points out that when someone tries to sell something to you, like an investment, it probably isn't worth buying. The best ideas come from your own ideas and digging.

8:06 AM: Would Buffett buy additional shares in the financials he already owns like American Express and Wells Fargo if prices come down? Is he buying shares now? Buffett replies that he has indeed been buying shares in one of those two names lately, but won't say which one. He points out that both companies were both started by the same people.

8:17 AM: Buffett repeats his belief that a windfall profits tax on oil doesn't make any sense, despite the fact that his favored candidate, Barack Obama, has expressed support for such a tax. He notes that no one is calling for a tax on other commodities that have gone up in price like soybeans. The oil companies are an easy target.

8:38 AM: Buffett says it's possible there could be another financial firm imposion along the lines of Bear Stearns, but it would be "inappropriate" to comment on any specific companies right now because it could undermine confidence. He notes that while it is hard to find the sources, rumor-mongers should be punished.

8:44 AM: Buffett predicts housing market recovery will take some time, probably years. "A lot of blame to go around." The market won't really come back until you get to a normal inventory of unsold homes.

8:46 AM: Buffett: No interest right now in buying any homebuilder stocks. They still have plenty of problems.

A video of Buffett's comments on housing is here.