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Why We Listen to Buffett

Written by Briton Ryle
Posted February 27, 2017 at 4:56PM

There is one statistic that sums up why we as investors listen to what Warren Buffett has to say:

Over the last 52 years (that is, since present management took over), per-share book value has grown from $19 to $172,108, a rate of 19% compounded annually.

Now, book value is not the same as a market valuation. Market valuation is the stock price. It is what you have to pay on any given day to own the shares. So market value changes often, with virtually every buy or sell order.

Book value should be more consistent. It is calculated as total assets minus total intangible assets and liabilities. Book value is meant to give a stable estimate of what a company should be worth if it were being purchased.

In any event, the fact that Buffett, his partner Charlie Munger, and the rest of management team have grown the book value of Berkshire Hathaway from $19 to $172,108 in 52 years is amazing. And if that performance doesn't impress you, then the 19% compounding should. 

19% may not sound like a huge number. But to grow 19% a year for 52 years? You might think that was impossible...

Tell that to the Buffett Millionaires: average American investors who invested with Buffett in the early days.  

Like Bill Scargle, who started with 10 shares in 1978 at $175 apiece. He cashed out a million dollars for his retirement after just 10 years, when the shares were trading for over $7,000 apiece. 

Ten shares were all it took to get started. Yes, Berkshire Hathaway shares appreciated at an amazing rate in those days. But it's the compounding of the investment that really makes the difference for the individual investor. If you compound at 19% a year like Buffett has done, you double your money in four years. Let it ride, and you double your initial investment again in just two more years. 

If you can add 10% of initial investment every year, you've made seven times your money after just nine years. 

This is the power of compounding. It doesn't take much to get started. But if you want to set yourself and your family up for life-changing wealth, get started ASAP...

"Washtubs, Not Teaspoons"

I read Buffett's annual shareholder letter every year. It's basically required reading for investors. The perspective and attitude Buffett displays is literally priceless.

Like this nugget:  

Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. 

I hope you see what he's saying here: when the economy tanks and goes into recession, this is when it rains gold. Because stock prices go into the tank, too. Buffett understands that they will not stay there. Prices will rebound. So while most investors are freaking out as the market prices of their investments drop day after day, Buffett is seeking opportunity. 

And I'll tell you something else: he doesn't wait for some kind of an "all clear" sign to start buying during a recession. During the financial crisis, he bought in 2007, right before the decline started. He bought in 2008, when the recession was just getting started. And he bought in 2009, when it looked like capitalism was coming to an end. 

Buffett gets it. He knows that stocks go up over time. As I've said before, it's a basic model: populations grow, so people buy more stuff, and inflation ensures that salaries and prices rise over time, so corporate revenue and profit rise, too.

Basic, but you'd be surprised how many people cannot see that when the market tanks, it simply means stocks are on sale. And when things are on sale, you buy. 

Buy With Cash

Here's another great lesson from Buffett: Buy things with cash. Don't cash out your investments to make purchases. As Buffett puts it:

I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter’s value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6 billion.

When Buffett used stock, he was using future earnings to buy Dexter Shoes. If he had just used cash, he would have been out $434 million. But by using stock, he was out $6 billion. Not that the Dexter family is worried about it...

That purchase made the Alfond family (that was majority owner of Dexter) the second-biggest Berkshire Hathaway shareholder, with 25,000 shares in 1993. In 2007, 25 years later, that stake was worth $4.2 billion. Today, as Buffett noted, that stake would be worth $6 billion.

So, don't cash out your investments to make a purchase. Like, an IRA account will allow a withdrawal to make a down payment on a house for a first-time homeowner. Resist the urge to do that. Leave your investments alone, and let them work for you. 

Buffett's Final Word

Here's a final nugget that bears reprinting:

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. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle...

During... scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

This quote has been repeated by Buffett in various forms many, many times. All investors struggle with fear when they see the value of their investments start falling. It's a natural reaction. And the last time it happened — in 2008/9 — it was especially bad. Investment accounts dropped by 50%, 60%...

If you held on, you were break-even at some point in 2013. Today, you are back solidly in the profit zone. And if you bought on the way down, well, you're doing better than average. 

But if you sold, you got what you got and that's it. You never made back those losses. And the cash you took out is likely worth less now than it was then. That's a lose-lose. A lot of data shows that there are fewer individual investors today than there ever have been. Many people don't even contribute to their employer-sponsored retirement plans.

No doubt this is in part due to the fear that the financial crisis created. And it's tragic. Because it means that many Americans are looking forward to a less prosperous future. You should contribute the maximum to your retirement plan. Your company likely contributes some money, too. This is free money. And it's free money that will grow over time. Take the free money.

And get yourself a Roth IRA, too. These tax-advantaged plans are the biggest gift to investors there's ever been. Because you don't pay capital gains taxes on the money. It's like free money. Take the free money.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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