Just Ducky? Swinging? Buffett on ‘97, ’98

Few annual-report letters to shareholders by corporate chief executives attract as much attention each year as Warren Buffett’s, but then, few CEOs write as well as Buffett--let alone invest as well.

Here, as culled by Times staff writer Tom Petruno, are some highlights from this year’s Buffett letter (dated Feb. 27), as reported on the World Wide Web site of his investment holding company, Berkshire Hathaway Inc.:

* On the rise in Berkshire stock last year: “Given our gain of 34.1%, it is tempting to declare victory and move on. But last year’s performance was no great triumph: Any investor can chalk up large returns when stocks soar, as they did in 1997.

“In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond.

“So what’s our duck rating for 1997? . . . Though we paddled furiously last year, passive ducks that simply invested in the S&P; [500] index rose almost as fast as we did. Our appraisal of 1997’s performance, then: Quack.”

* On the U.S. stock market overall: “Though we don’t attempt to predict the movements of the stock market, we do try, in a very rough way, to value it. At the annual meeting last year, with the Dow at 7,071 and long-term Treasury yields at 6.89%, Charlie Munger [Buffett’s investment partner] and I stated that we did not consider the market overvalued if 1) interest rates remained where they were or fell, and 2) American business continued to earn the remarkable returns on equity that it had recently recorded.

“So far, interest rates have fallen--that’s one requisite satisfied--and returns on equity still remain exceptionally high. If they stay there--and if interest rates hold near recent levels--there is no reason to think of stocks as generally overvalued. On the other hand, returns on equity are not a sure thing to remain at, or even near, their present levels.

“In the summer of 1979, when equities looked cheap to me, I wrote a Forbes article entitled ‘You Pay a Very High Price in the Stock Market for a Cheery Consensus.’ At that time skepticism and disappointment prevailed, and my point was that investors should be glad of the fact, since pessimism drives down prices to truly attractive levels.

“Now, however, we have a very cheery consensus. That does not necessarily mean this is the wrong time to buy stocks: Corporate America is now earning far more money than it was just a few years ago, and in the presence of lower interest rates, every dollar of earnings becomes more valuable.

“Today’s price levels, though, have materially eroded the ‘margin of safety’ that [Buffett mentor] Ben Graham identified as the cornerstone of intelligent investing.”

* On his reluctance to commit Berkshire to new investments, and his frustration with that situation: “Though we are delighted with what we own, we are not pleased with our prospects for committing incoming funds. Prices are high for both businesses and stocks. That does not mean that the prices of either will fall--we have absolutely no view on that matter--but it does mean that we get relatively little in prospective earnings when we commit fresh money.

“Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book ‘The Science of Hitting,’ Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his ‘best’ cell, he knew, would allow him to bat .400; reaching for balls in his ‘worst’ spot, the low outside corner of the strike zone, would reduce him to .230.

“In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors. If they are in the strike zone at all, the business ‘pitches’ we now see are just catching the lower outside corner. If we swing, we will be locked into low returns. But if we let all of today’s balls go by, there can be no assurance that the next ones we see will be more to our liking.

“Perhaps the attractive prices of the past were the aberrations, not the full prices of today. Unlike Ted, we can’t be called out if we resist three pitches that are barely in the strike zone; nevertheless, just standing there, day after day, with my bat on my shoulder is not my idea of fun.”

* On the stock market’s gyrations: “A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves. But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?

“Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the ‘hamburgers’ they will soon be buying.

“This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

Berkshire Hathaway’s Web site address: https://www.berkshirehathaway.com

* VARYING VIEWS: Stocks’ rally deepens disagreements over market’s future. A1