Investing
10 Lessons of Sanity From Warren Buffett During Insane Markets
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Investors have had their first real taste of volatility and pain in 2018. The bull market is now right at nine years old, and by the end of January it had been almost two years since the stock market had even seen a 5% market correction. That all changed during the first full week of February, when the stock market went from a 5% sell-off down to a 10% sell-off in a matter of hours. This rapid price action blindsided many investors, and now some are understandably rethinking how they should be positioned ahead.
Periods of uncertainty can turn into periods of panic. The markets just demonstrated that. Investors have seen that markets go up, but they have to remember that the markets also go down and that certain market corrections are both necessary and can bring opportunities. The whole notion that markets can go down seems to have been forgotten about because the market was only going up and up every week for so long. It’s during times like this that investors have to think rationally and with purpose about their investing strategies. Perhaps this is when it would be a good time to think of some investing strategies that Warren Buffett would employ.
The public and investors alike seem to love and cherish Buffett. He has a cult following at the Berkshire Hathaway Inc. (NYSE: BRK-A) annual meeting that the Berkshire holders call “Stockpalooza.” And Buffett is called the “Oracle of Omaha.” And even for Buffett’s critics, everyone can probably agree that having become the world’s richest man almost certainly implies that Buffett knows a thing or two about business and investing.
24/7 Wall St. has tracked many topics and trends about Buffett over the years. We have tracked the major changes in his portfolio of stocks, we have tracked his many acquisitions and we have watched many of his interviews and actions he has taken over the years. It turns out that Buffett has a plethora of actionable methods and theories that the Average Joe investor can use in good times — and in hard times. And most people would admit that they think they are investment gurus on the way up and that they “didn’t get enough help” from others on the way down. Since human nature is hard to avoid, why wouldn’t investors flock to the practices of one of the greatest human investors ever?
When it comes to extreme buying and extreme selling, Buffett is known for saying “Be fearful when others are greedy, and be greedy when others are fearful.” This message about not always following the crowd should be clear enough, but there are so many other rules and generalities that Buffett employs that it can be hard for the average investor to keep up.
Investors have to keep in mind that many of the great business climate changes are only just now taking hold, even if the financial prices of their shares might have built in a lot of good news. Corporate tax reform was explained by Buffett as a chance for companies to keep almost 80 cents of every dollar they earn after taxes rather than paying out more than one-third of every dollar they earn in taxes. Buffett recently said he would have created a different tax plan, but he also admitted that he and the bulk of corporate America will benefit greatly from tax reform. And there are lower regulations to consider as well.
The following are not in any particular order, but here are 10 lessons of sanity for investors to always consider when markets begin to act less than sane.
1. Employing Rules-Based Investing Strategies
It’s always important for investors to consider what a company has for leadership, how defensible its business moat is and how profitable a company is. Jefferies once outlined the 13 point checklist that Buffett’s investments and acquisitions fit within. 24/7 Wall St. has even outlined 10 strategies for common investors to invest like Buffett using a mindful long-term view with a simple and straightforward approach.
Buffett might not always follow his own rules to the tee, but he seems to end up being right more often than not. Maybe using rules-based investing decisions should be a good start investing sanely during periods of insanity in the markets.
24/7 Wall St.2. Taking Advantage of Business Model Changes
Buffett gave a good sharp reminder to admit that sometimes the investment thesis can change within a company. This was the case in May of 2017 when it was first revealed that Buffett had started selling out a large portion of his stake in International Business Machines Inc. (NYSE: IBM). Buffett even said he didn’t sell because of earnings disappointments but because he did not value IBM the same way he did six years earlier.
It is also the case, one that in hindsight Buffett should have avoided, but during the retail plummet of 2016 and early 2017, Buffett decided that the Amazon.com Inc. (NASDAQ: AMZN) death star was big enough that he rethought his investment in Walmart Inc. (NYSE: WMT) — and the pressure of Jeff Bezos made him dump the mighty Walmart.
Rethinking an investment thesis also allowed Buffett to finally decide to buy into Apple Inc. (NASDAQ: AAPL) in the first half of 2016 after Apple shares had lost one-fourth of their value from a year earlier.
3. Understanding How Taxes on Gains and Losses Impact Over Time
Sometimes it can be very tempting to lock in big gains in stocks that may seem less attractive today than they did a year ago, five years ago or even more than a decade ago. The problem with selling big gainers is that the taxes have to be considered for whatever else you might be wanting to buy. Buffett had five big positions where the profits were north of $10 billion each back in 2017, but whatever tax rate has to be paid implies that a new position as a replacement has to be undervalued by that same amount for it to make sense. Otherwise, the sale isn’t a wash sale per the IRS rules but it may in effect be a wash to the investor.
And on taxes, there is a reason that most investors should look at opportunities for long-term gains rather than short-term ones: you get the long-term capital gains treatment in taxes and not taxed at your income tax rate.
4. Keeping a Basket of Great Businesses
Buffett sometimes sounds like a puppet when he is quoted on variations of “America’s best days are ahead of it.” That being said, his investment themes have done better than most investors’, and he is considered to be among the best modern-day investors of them all. Buffett’s 2016 annual report outlined how good businesses should be viewed as a whole basket rather than just based on the market sentiment of a day, week or even longer when times are tough: “American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.”
And on keeping a great basket of businesses, it is not uncommon for Buffett and Berkshire Hathaway to own stakes in 50 or more companies at a given time. Some of us call that diversification.
5. You Can Change Your Mind and Outlook
It’s okay to change your opinion of something even after years of dislike. This can be applied to sectors, stocks or even the market in times of extremity. Buffett personally would not have ever invested in the airline industry for many years. A multi-billion airline bet was made by one of Buffett’s top new investment team members (Weschler/Coombs). But then the airlines had finally consolidated into a few companies with defendable moats, with major pricing power on tickets, reliably low jet fuel prices and even the power to start gouging customers on fees and policies.
Buffett had in the past referred to the airline industry a death trap, and Buffett had even gone as far in prior years to say that the best airline bet would have been to shoot the Wright brothers down. After the portfolio managers bought the major airlines, Buffett even ordered that Berkshire Hathaway should buy into Southwest Airlines Co. (NYSE: LUV), as Buffett told CNBC that he didn’t want Herb Kelleher thinking he did not favor Southwest out of the other legacy carriers.
It’s okay to change your mind about industries and sectors over time, and that needs to be considered if the prices of certain companies or sectors become too cheap during a market sell-off. Buffett has also rotated in and out of energy sector shares so many times that he obviously changes his mind about the future of oil and gas too.
6. Avoiding Bubble Areas
It’s okay to think an asset can be in a bubble, even if you missed the big run higher. Some modern and classic investors fight over how to view bitcoin, but bitcoin’s meteoric rise from under $1,000 to almost $20,000 has seen the cryptocurrency then lose over 60% of its value in a very short time. It’s easy to argue that Buffett (and most of the rest of us) missed the great bitcoin bubble inflating. He started calling bitcoin a mirage back in 2014.
If an investment or a financial class is too hard to understand or if you just cannot agree on how sound the fundamentals are. then it’s fine to keep away and look elsewhere for how you should invest within your risk tolerance. Buffett does not chase bubbles in technology or other areas of the stock market. This may have come with a lot of opportunity costs, but he likes to stick with what he can easily understand.
7. Picking Your Price for Value
A classic sense of investing in Buffett is one in which there just might be no one single instance. Buffett has employed the theory of value investing for years, but that might not just be a low price-to-earnings (P/E) ratio. Buffett is willing to be opportunistic, and sometimes Joe Public can think like Buffett if it seems that the stock market carnage is becoming too great.
In this instance, the strategy would be to put together a list of the companies you think are the best run that will do well in the long-term business cycle changes and pick your price. If a stock was too expensive or had run too much without pullbacks at $50, think about what price you are willing to pay and set limit orders. If the market loses its sanity and the company’s stock drops to $35, you might be willing to own it there, even if you have no idea whether you caught the bottom.
8. Patience, or Discipline
You don’t have to buy your shares all at once. There are too many instances to count when Buffett and his team start a position in a new stock that does not look massive at first, but then you see the team grow the position, and sometimes they keep adding to that position. This was seen in Apple, and the best example was Wells Fargo & Co. (NYSE: WFC). Buffett accumulated shares for many years, up until its most recent woes.
Some investors also refer to this as “legging in” on a position, and when stocks are falling the traditional buying at various prices is thought of as “dollar cost averaging.” Now think about this: you don’t have to sell your winning or losing shares all at once either.
9. Lower Prices Alone Do Not Make Companies Cheap
Sometimes there are certain stocks with a price that keeps falling. It may have been a great business before, but it’s important to know that you should not try to catch a falling knife. Buffett has come to the rescue of many companies before (General Electric, Goldman Sachs, Bank of America and so on), but those are generally in times of need when Buffett thinks he can get a steal (he got better terms than the government in TARP).
Then there are instances when management has hurt a company, or when the management team has lost the trust of the public and shareholders. Buffett does not go after companies with accounting irregularities, and most investors should take that into consideration. If a stock fell to $40 from $50, it’s probably “cheap” for a reason, and that alone does not entice Buffett when there are internal problems in a company.
10. Picking Good Dividends and Buybacks as Backstops
When the financial markets become uncertain, some investors decide to hunker down in companies that have safe dividends and are also buying back stock over time. Buffett himself rarely buys back Berkshire Hathaway shares, and he doesn’t pay his Berkshire shareholders a dividend, but go look at his investment portfolio. It’s full of companies that have safe dividends that grow over time.
Dividends being safe means that there is little or no risk to a company’s ability to pay those same (or better) dividends in the years ahead, even if a recession comes. Buffett’s portfolio of stocks is also full of companies that have used capital to buy back their own stock to lower the float of shares.
Depending on the business cycle and the sectors selected, dividends alone can account for one-third to half of investors’ total returns over time. And in periods of uncertainty, sometimes companies with multibillion stock buyback plans might be the biggest buyer of stock during weak markets.
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