It is a mark of Warren Buffett’s smart investment choices over the years that whenever he decides to pass on his wisdom, value investors are all ears. Investors vouch that their best investment tips have come from their reading of Buffett’s annual letters. His letters are slangy and hard-hitting which showcase his chops for wit.
This year’s annual letter was no exception. It had the Buffet brand of humour in oodles. For Indian investors, the Oracle of Omaha’s word is gospel. How else would you explain the fact that after news of Buffet buying airlines stocks was leaked in the US, Indian airline companies rallied on our bourses? Well, here we take a closer look at whether there is any logic in such a lemmings-like reaction. We also try to understand the relevance of other key issues raised by Buffett in his letter.
From Indian shareholders’ point of view Buffett raising the topic of share buybacks could not have come at a more appropriate time. The IT sector has seen institutional investors demanding companies with huge cash piles to announce a buyback. Infosys, which recently announced its decision to buy back shares, has been made a whipping boy of an industry where founding members of companies are rejoining the board seeking an increase in the share value.
In US, however, debates are centered on the utility of buybacks. Buybacks are being considered as corporate misdeeds that divert funds needed for productive endeavours.
Buffett in his letter referring to buyback says ‘What is smart at one price is stupid at another’ highlighting that buybacks should be done only if shares are available below intrinsic price. He adds that there are two occasions in which repurchases should not take place, even if shares are underpriced. One is when a company needs all its available money to protect or expand its own operations, and is also uncomfortable in adding further debt. Here the internal need for funds should take priority. The second exception, less common, materializes when a business acquisition (or other investment opportunity) offers far greater value than do the undervalued share.
In the case of Infosys , its CEO and board members are of the opinion that they need the money for acquisitions and investment for future growth which offers greater value than buying back their own share.
Low-cost Investing: Buffett has always been a proponent for low-cost investing. He has rubbed many a fund managers on the wrong side for charging very high fees.
Buffett has a valid piece of advice for retail investors. He says in his letter ‘Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behaviour. My regular recommendation has been a low-cost S&P 500 index fund. To their credit, my friends who possess only modest means have usually followed my suggestion.
I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed that same advice when I’ve given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or, in the case of many institutions, to seek out another breed of hyper-helper called a consultant.
In Indian context, too, this advice holds. Index funds have the lowest expense ratio among mutual funds; in most funds it is lower still by 10-20 percent. In cases of portfolio management services the fees or investment rises multifold leaving a mediocre performance in the hands of the investors.
It is generally the fund house and their consultants who are always laughing their way to the bank.
A market crash is a good opportunity
One of the most used quotable quotes from Warren Buffett is ‘Be fearful when others are greedy and greedy when others are fearful.’
On markets Buffett’s letter mentions that the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – “not me, not Charlie, not economists, not the media.”
During such 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.
The same holds true for Indian markets. Some of the best stock-picking are available in the rubbles of a stock market crash, be it in the US or India.
Buffett’s sale and purchases
Buffett has picked up sizeable stakes in airline stocks. Indian airline companies rallied on the news. Defending his investment thesis Buffett said that airlines has a ‘bad first century’ referring to the twentieth century when nearly 100 airline companies went bust in the US.
Buffett said that consolidation has taken care of the boom and bust cycle with carriers operating at higher capacities. That is essential, he said, because having too many seats forces airlines to slash prices and “go broke over time.”
Indian airline industry is at a comparatively very nascent stage with one company – Kingfisher Airlines going bust and another one – Air India on the respirator for a long time, thanks to government’s persistence.
However, occupancy rates in India has picked up which lends some hope for a long-term rally. But Indian airline companies are extremely vulnerable to oil prices and do not have the kind of flexibility to raise prices that US airlines have. The rally, if it is based on Buffett purchases is an overreaction.
One of the stocks that Buffett completely divested was Wal-Mart. Explaining his $900 million exit from the retailing giant Buffett said “I think retailing is just too tough or me. We bought a department store in 1966 and I got my head handed to me. I’ve been in various things in retailing … I bought Tesco over in the UK and got my head handed to me. Retailing is very tough, and I think the online thing is hard to figure out.”
This statement from Buffett comes just days before Indian retailer D-Mart’s IPO. It can force a re-think on Buffett’s fans who were keen on investing in the IPO. But Buffett has nailed the e-commerce industry, the turmoil of which is now visible.