It’s hard to argue against the idea that Warren Buffett’s one of the best investors in the world today. Over the past 50 years from 1965 to 2015 as leader of Berkshire Hathaway, Buffett has grown the company’s book value per share – a proxy for the firm’s true economic worth – by a stunning compound annual rate of 19.2%. And, he had done it largely by using Berkshire’s funds to invest in the stock market and acquire companies with great businesses. But, Buffett wasn’t born with the knowledge to invest. There were people who guided him along the way…
It’s hard to argue against the idea that Warren Buffett’s one of the best investors in the world today.
Over the past 50 years from 1965 to 2015 as leader of Berkshire Hathaway, Buffett has grown the company’s book value per share – a proxy for the firm’s true economic worth – by a stunning compound annual rate of 19.2%. And, he had done it largely by using Berkshire’s funds to invest in the stock market and acquire companies with great businesses.
But, Buffett wasn’t born with the knowledge to invest. There were people who guided him along the way and the most influential investing mentor Buffett had was Benjamin Graham. Graham was a lecturer, fund manager (Buffett had studied under Graham as a student and also worked for his fund as an employee), and also the author of the influential investing texts, Security Analysis and The Intelligent Investor.
I thought it’s a great speech and it’s likely not well-known at all considering that even Buffett was unaware of it when Zweig found a copy and sent it to him. As such, I thought it’d be good to share some of my favourite parts of Graham’s speech along with my comments, just so that more investors can be aware of it.
On how market prices can affect your judgements:
“There is a lot of juggling with figures that can be done now as always [to value the stock market]; but none of these methods in itself gives a dependable result. To a great extent the figures selected are determined by the general attitude of the man who is selecting them, and that general attitude is very often determined in turn by what the stock market has been doing.
When the stock market is at 750 you take an optimistic attitude and use some favourable figures; but if it should have a severe decline most people would jump back to the older and more conservative evaluation methods.”
When thinking about how cheap or expensive stocks are, it may be worth noting that our assessment may be coloured by the prices of stocks. In my opinion, one good way to counter this is to use the current market price of a stock and work out how much growth the market’s expecting from the stock’s business.
On human nature in the stock market:
“[W]e are still going to have wide fluctuations [in the stock market] in the future… My reason for thinking that we shall have these wide fluctuations… is that I don’t see any change in human natures vis-à-vis the stock market which is sufficient to establish more restraints in the public behaviour than it showed over so many decades in the past.
The actions of the public with respect to low-grade new issues during the 1960-1961 extravaganza in that field are an indication of its inherent lack of restraint. You ought to remember also, that many of the highest grade common stock issues were forced up to excessive levels by a market enthusiasm which produced large subsequent declines.
Let me give you some examples: The most impressive to my mind was that of International Business machines which is undoubtedly the leading common stock in the entire market. Speculative enthusiasm pushed it up to 607 in December 1961, from which it declined to 300 in June 1962 – a fall of more than 50% in the short period of 6 months. General Electric, which is the oldest high grade investment common stock, declined from a high of 100 in 1960 to 54 in 1962.”
So long as humans are involved with the stock market, it’d appear that huge price fluctuations are here to stay. During the Great Financial Crisis of 2007-09, more than four decades after Graham’s speech, there were still massive price movements in stocks that were akin to the experience with International Business Machines and General Electric that are seen above. We can take, for instance, Singapore Exchange Limited (SGX: S68) and Sembcorp Marine Ltd (SGX: S51).
Singapore Exchange had climbed to a peak of S$16.40 on October 2007 just before the crisis and was valued at 41 times trailing earnings; the company’s shares subsequently fell by over 75% to S$4.02 on March 2009 at its bottom during the crisis. At the price of S$4.02, Singapore Exchange had a trailing price-to-earnings (PE) ratio of merely 12.
It’s a similar thing with Sembcorp Marine. The company’s shares hit a high price of S$5.60 on October 2007 before the financial crisis. The stock then plunged by 78% to S$1.23 on October 2008, only one year after the high. On the dates when Sembcorp Marine’s shares hit their high and low points during the crisis, the firm had PE ratios of 38 and 8, respectively.
On why stock market forecasting techniques don’t work:
“Now, with respect to stock market forecasting… I don’t think there is any good evidence that a recognised and publicly used method of stock market forecasting can be relied upon to be profitable. Let me illustrate what I mean by reference to the famous “Dow Theory” which is the best known of the methods used for forecasting the stock market.
I made some elaborate studies of the results of applying the mechanical concepts of the Dow Theory, in which you have well-defined signals to buy and sell stocks by the movement of the average through resistance points upward or downward.
I found that when I studied the record from 1898 to 1933, a period of about 35 years – the results from following this mechanical method were remarkably good. About 1933, the time when the Dow Theory had shown itself a very useful method for dealing with the market action in the 1920’s and early 1930’s, the public’s interest in the Theory increased enormously. Previously it had been a kind of esoteric prescription followed only by a few devoted adherents, and about which everybody else had been pretty skeptical. The Dow Theory became extremely popular after 1933.
I studied the consequences of using exactly the same method in the market after 1933, and I found peculiarly enough that in no case in the next 25 years did one benefit through following the Dow signals mechanically. By this I mean that one was never able to buy his stocks back at a lower price than he sold them for.”
It’s worth remembering how easy it can be for stock market forecasting techniques to lose their ability to work – all it requires is for more investors to know that such a method exists. Graham didn’t mention it, but it seems that there’s no easy way as well for investors to know just when a technique will stop working. If you’re interested in trying to forecast what the stock market will do, you may want to approach the forecasting with caution.
Here’s the link for Graham’s speech again. Go on and take a look – I think it’d be well worth your time.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway.