Dear fellow investors,
You have to love The Wall Street Journal writer, Jason Zweig. His extremely inciteful “Intelligent Investor” column could be called “Jason’s Wet Blanket,” because he seems to throw a wet blanket on most investment disciplines in U.S. stocks. This week’s wet blanket is designed to create even more desperation for value investors via his interview with Charlie Munger.
Rather than telling Zweig to be “greedy when others are fearful,” Munger talked about protecting Berkshire Hathaway (BRK) “for those who have 90% of their net worth in the stock.” Munger’s first point was that nobody has called him and Warren Buffett offering what they call “elephant-sized” investments or desperation bargains. “The typical reaction is that people are frozen,” he said. “The playbook doesn’t have this as a possibility,” he added, referring to the coronavirus economic contraction.
Second, Munger is perplexed by this government-mandated recession which appears unanalyzable to him. He said, “This thing is different (aka this time is different)!” We love that Munger seized on the thought that this time is different, because IT IS AWAYS DIFFERENT! However, each time that is different “rhymes” with past situations. If you weren’t focused on protecting those who have 90% of their net worth in your stock, you might go back to analogous situations to look for those rhymes.
“If there is light at the end of the tunnel, you are too late!” Sir John Templeton
Unfortunately, Jason Zweig made little effort to flush out what Munger said in relation to historical context. He didn’t compare this to 1972-1974 when an oil embargo, gas rationing and inflation were the virus. Berkshire Hathaway is gigantic, owning vast swaths of the U.S. economy in wholly-owned businesses. It came into this with over $120 billion in cash and produces copious amounts of new cash each quarter. Munger has pointed out every year for the last ten years at the Berkshire Annual Meeting that its size will retard future returns. He forgot to mention what would happen if large-cap stocks got too expensive and then got even more expensive by profiting from everyone’s misery in the quarantine.
Zweig chose to not talk about the historical divide between small and large-cap stocks or value versus growth, because Berkshire Hathaway has no ability, due to size limitations, to participate in the decimated sectors.
Source: Cypress Research, March 27, 2020. Data for the time period 1/1/970 – 1/31/2020.
Two months ago, the S&P 500 Index was at all-time highs, 19-times earnings and massively over-weighted in popular large growth companies. Those quality growth names have soared on a relative basis in this miserable market environment, just like the “Nifty-Fifty” stocks did in 1972. Bingeing on large growth glamour in 1972 led to a devastating bear market in 1973-1974 which lasted 22 months and removed 40% of the S&P 500 market cap. Buffett was interviewed at the bottom in 1974 and said, “I feel like an over-sexed guy in a harem!”
What did Buffett buy near the lows in 1974? He bought shares in The Washington Post and bought the entirety of See’s Candy. They were tiny. It looked like a harem to Buffett because the opportunities fit well inside his base of capital. As multi-decade fans of Buffett and Munger, we see value opportunities in homebuilders, select retailers/malls and in the energy space which has been left for dead. We got out of Occidental Petroleum (OXY) on the way down, but doesn’t OXY have phone service anymore? In that call to Buffett, he could buy the whole company for a song near record low oil prices and pays all their debts off at a huge discount to par value.
Also, Buffett in 1974 had not fully been indoctrinated in Munger’s “quality at a reasonable price” strategy. For that reason, the Coca Cola’s, Disney’s and Apple’s hadn’t yet been front and center. They both argue that what they learned from owning See’s taught them a great deal about brands. Do not forget that Coke traded in 1980-1982 for six times earnings and was paying a 5% dividend. In 1972, at the end of the year, it traded for 60 times profits. By 1981, Coke and other glam growth stocks were beaten down by 11% inflation, and in Coke’s case, embarrassed about buying Columbia Pictures! Buffett paid six times that share price to buy in 1989.
Which brings us back to today. Our takeaway from this interview is as follows:
- The opportunities in large cap are limited to places like the financial companies already owned by Berkshire Hathaway (AXP, BAC, JPM, WFC).
- Berkshire has virtually no way to play small-to-mid cap value like Buffett did all the way through the 1970s, due to its size.
- Berkshire won’t be able to deploy its capital until large-cap growth stocks get crushed or someone offers them their entire company.
- Buffett should have paid out dividends the last five years or bought back stock. The cash is only useful for sleeping well at night until large-cap growth and their fraternal twin brother, the S&P 500 Index, get filleted.
- Maybe the courage required for this circumstance must be connected to smaller capital bases because it is always different this time.
- We have probably returned to where Buffett was in the 1950s, 1960s and the bottom in 1974—a value manager’s harem. There is almost no capital in the hands of value managers, who provide liquidity on the downside. Historically, these circumstances normally coincide with long stretches of value outperformance or huge outperformance like 2000-2003. We like Mr. Market’s prices.
“Good investments don’t just walk up and bite you on the bottom and say, ‘We’re here!’”
– John Houseman for Smith Barney
Warm regards,
William Smead
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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