As the world’s most famous investor and arguably. One of the most successful investors of all time. The Warren Buffet Way has stood the test of time – or has it? Here is our take on the Warren Buffet Way and why it may not work in every modern-day market situation:
Unless you’ve been living under a rock for the last 50 years. It’s pretty hard to not have heard of Warren Buffet. As one of the world’s most famous and successful investors of all time. Warren Buffet founded a fund called Berkshire Hathaway in the late 50’s. And Warren Buffet’s mode of operation since inception has been nothing shy of grand. As rather than buying 100 shares in a given company for his fund. He typically might purchase 5,10, even 15% of a company he buys into – as an example. The guy owns over 5% of Apple. Over the years, Berkshire Hathaway has generated billions of dollars in profit for their investors says host Andrew Baxter. However more recently over the last 10-15 years hasn’t quite performed to the standard it once did.
Stock Valuation and the Warren Buffet Way
Warren Buffet is most famous for the book he wrote on stock valuation which is the ‘Warren Buffet Way’. And Warren use as ‘Price to Earn’ (PE) ratios to value stocks. And pick future out performer for his Berkshire Hathaway fund to invest in. The challenge he face since the dotcom boom particularly pertains to stock earnings. As with tech stocks, traditional valuation methods like the PE ratio are tough to apply. Also, given those stocks trade at such a high premium for the earn they could generate down the line. Not the earnings they have already generated.
The Stock Market is Overvalued
One of the more recent developments of Buffet has been the valuation of the stock market relative to economic GDP. As a new method of valuation. Regardly, Buffet has taken the market capitalization of the stock market and divided that by annual GDP output to work out the effective PE ratio of the entire market. Relative to the performance of the economy. And what he found was staggering – the stock market is trading at a premium of around 243%. Also, which based on historical measures is about 95% overvalued. Under normal conditions, any savvy investor would be gearing up for a market correction. To come back to some level of sensibility. However, we aren’t in normal conditions. And really the main driver of this has been the super-hot performance of the giga-cap tech stocks.
Why Buffet has Underperformed
It really is no surprise when we say that the hottest race in town of the last 5-10 years of the stock market has been in the technology sector. As host Andrew Baxter says, the valuation tools for tech stocks are extremely different to the traditional tools given their earnings are ‘forecasted’ down the line. For example, if we take a look at some examples – Tesla is trading at around 392x their earnings and Afterpay 171x just to name a few. If you’re Warren Buffet, you aren’t touching these stocks with a stick. As they are so massively overvalue by any traditional stretch of the imagination.
This is hence why Berkshire Hathaway has perform the stock market for the last 15 years – a lack of exposure to these forward looking. High growth technology stocks. These stocks have become such a dominant component of our market. However, is not something Buffet tends to consider. Is he wrong for this? Or does he know something we don’t?
Advice for Retail Investors
As a new retail investor, navigating these bizarre market conditions can be a little challenging. Yes, there has been an insatiable amount of growth out of the tech sector recently, however, when some of these shooting stars come back to earth – those value investors, like Buffet, will have made the right call. As host Andrew Baxter suggests, these disruptive tech companies have done an amazing job at shaking up the makeup of their niche and gaining quick market share. Nonetheless, these giga-cap stocks overvalue and so must buy with caution.
So, Is Buffet wrong by not having exposure to these kinds of businesses? Our answer is a hard no. There is a reason that Warren Buffet is the most successful investor of all time, thus, if you’re looking to enter markets the advice is to simply just ensure you’ve got a spread of companies in your portfolio. Having the traditional Buffet businesses in your portfolio is just as important as having some exposure to tech stocks – to learn more, reach out to Australian Investment Education.