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When Junk Is Winning, Run Far, Far Away
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Buffett’s words of wisdom… Cutting Michael Jordan… Quality versus junk… What happens in market manias!… Looking at data back to 1956… Peak oil still a myth… Venture Global gets more deals… A 50-year mortgage?… |
Table of Contents
In his 1996 shareholder letter, Warren Buffett gave away many of his greatest secrets.
He wrote about the importance of time (inactivity):
We continue to make more money when snoring than when active.”
While humans have emotional and biological urges for action, the very best investment policy is almost always to do nothing.
He explained the supremacy of quality businesses:
The art of investing in public companies successfully is little different from the art of successfully acquiring subsidiaries. In each case you simply want to acquire, at a sensible price, a business with excellent economics and able, honest management.”
He explained the extreme power law (Pareto’s Law) in the markets by comparing great businesses to basketball great Michael Jordan.
When carried out capably, a [high-quality] investment strategy will result in its practitioner owning a few securities that will come to represent a very large portion of his portfolio… To suggest that this investor should sell off portions of his most successful investments simply because they have come to dominate his portfolio is akin to suggesting that the Bulls trade Michael Jordan because he has become so important to the team.”
And he explained one of the attributes of long-lived, high returning investments: a moat unlikely to be threatened by technological change.
You will see that we favor businesses and industries unlikely to experience major change. The reason for that is simple: Making either type of purchase, we are searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twenty years from now. A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek.”
He labeled these kinds of investments “inevitables,” and savvy subscribers will notice how I’ve slavishly adopted these ideas as my own with many of my best, all-time recommendations: The Hershey Company (2007), Microsoft (2012), W.R. Berkley (2012), American Express (2016). And I’m sure you’ve noticed that trend has continued at Porter & Co., with what will become the greatest recommendations of my career: Philip Morris International (2022), Domino’s Pizza (2023), Deere & Co. (2023), Diageo (2023), and Kinsale Capital (2024), among others.
But… Buffett’s greatest secret of all was published 10 years earlier.
In his 1986 letter, Buffett wrote:
Be fearful when others are greedy, be greedy when others are fearful.”
This advice is critical because, as I’m sure you’ve noticed over time as an investor, the value of a public company’s earnings vary depending on the mood of the market. Sometimes investors will pay 25x earnings. And sometimes, not much over 10x earnings – even for great businesses.
As Buffett reminded us in 1996:
You can, of course, pay too much for even the best of businesses… Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.”
Buffett’s greatest secret – to be fearful when others are greedy and to be greedy when others are fearful – is largely ignored because, first of all, a frothy market that’s going higher virtually every day looks like the best time to make a lot of money in stocks.
Plus, it can be very difficult to know if stocks are trading at high valuations because their prospects are legitimately improving. Ironically, that was the case in 1996, when Buffett gave this warning. It was the beginning of the internet era, an incredible period where computer and communication technologies vastly increased productivity – permanently. The market was rationally discounting the long-term impact of improved margins and returns on investment. Buffett was wrong.