The stock market doesn't seem to hold much promise right now, but any market is a good one in which to practice the approach followed by Warren Buffett, the legendary chairman of Berkshire Hathaway Corp. That's the analysis of Timothy Vick, senior analyst for Arbor Capital Management and author of How to Invest Like Warren Buffett.
Among the elements of his strategy is a search for consistency of performance, growth in return on equity, and growth of shareholders' equity. Patience is another Buffett attribute: Vick points out that the Sage of Omaha has stuck to Gillette and Coca-Cola through earnings disappointments that would have driven others away. And Vick says he follows the Buffett philosophy in his own investing.
These were some of the points Vick made in a chat presented May 9 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and David Shook of BW Online. Edited excerpts of the chat follow. A complete transcript is available from BusinessWeek Online on AOL, keyword: BW Talk.
Q: What's your macro view of this yo-yo market?
A: I think it will remain a yo-yo market for probably the next couple of years, or at least until corporate earnings catch up to current valuation levels. Individual investors should be looking at companies that can greatly outperform the S&P 500 going forward. I think the stage is set for a decent rebound in the economy, but I'm not so sure that corporate sales will rebound at rates that will translate to the bottom line and push up stock prices.
Q: What's your take on capital spending?
A: Right now, I see virtually no signs of it picking up except in a few scattered consumer companies.... But the kind of spending that juiced the economy in the 1990s is still rather dormant. We seem to be hearing more stories of companies cutting their capital budgets in 2002 and 2003 rather than stories about companies increasing them. That worries me. Anytime a company such as Lucent (LU) decides to cut its capital budget by $100 million, it's taking $100 million in sales away from companies that Wall Street was relying on to rebound next year.
Q: Re the Buffett philosophy -- what does he value?
A: Mr. Buffett is a new-era value investor. He is particularly interested in sustained high returns on equity and steady growth in shareholders' equity. As we've seen the past few years, companies have dozens of ways to manipulate their earnings, but relatively few ways to manipulate shareholders' equity. If investors would focus on growth in equity, rather than growth in accounting earnings, they would be better off.
Q: You were at the annual meeting of Buffett's Berkshire Hathaway (BRK.A) on May 4 (see BW Online, 5/7/02 "Spicey Talk from the Sage of Omaha"). Did you gain any new insights into his strategy?
A: The remarkable thing about Mr. Buffett is that he has been so consistent for all of his 55 years in investing that one can read his annual reports from today and compare them to his writings from the 1950s and see virtually no difference.
He looks at companies the same way, even though the names, prices, and amounts of earnings have changed drastically. There is a permanent truism to what he talks about every year at his meeting. Every company, no matter whether it produces fiber-optic equipment, motorcycles, or plates of steel, should be evaluated identically. These companies differ only in the shape of the output that comes off their assembly lines.
This year, particularly, Mr. Buffett was harsh on the accounting industry and all the mechanisms that Corporate America has been using to prop up earnings. He has suggested in the past that perhaps hundreds of U.S. companies have been manipulating their books just to satisfy Wall Street. The situation has gotten flagrantly worse, and now people are waking up, finally, to what Mr. Buffett has been saying all these years. That may be why this year's annual meeting saw record attendance.
Q: Can you talk about what consumer stocks Buffett likes best now?
A: Well, he certainly has been holding on to Gillette (G) and Coca-Cola (KO), which means he can certainly not be scared out of a company by short-term earnings. H&R Block (HRB) is a relatively new addition to his portfolio.
To date, he has made very good money on his purchases of Block and of Moody's Corp. (MCO) [holding company for Moody's Investor Services]. Going forward, we may see occasional purchases of large blocks of consumer companies by Mr. Buffett. But until valuation levels recede some more, we are likely to see him buy private companies in whole and bring them under Berkshire's wing.
In retrospect, Mr. Buffett deserves an A+ for the way he has navigated -- and mostly avoided -- this bear market.... He has positioned Berkshire Hathaway beautifully for strong gains in operating profits and shareholders' equity for the next few years. And he has done this without adding leverage to the balance sheet...without the prop of spurious accounting.
Q: In your own investment management, do you practice what Warren Buffett preaches?
A: Almost to the letter. I don't buy stocks just because Mr. Buffett is buying them, but I tend to look at the same types of companies at the same time, and apply the same kind of strengths to them. At this time, I'm looking at a few things: established, large-cap companies that have been beaten down to the point where they offer long-term, very strong returns, and special situations that offer me a high probability of good returns in the short term.
I have two types of accounts at my money-management business: diversified, value-oriented accounts, and special-situations accounts where I try to mimic the partnership model Mr. Buffett used so successfully in the 1950s and '60s.
Q: What are your top holdings in the value-oriented arena?
A: We bought Moody's right around the time it was spun off from Dun & Bradstreet. So far, it has worked out quite well. We have also been heavy buyers of late in the pharmaceutical sector, especially Merck (MRK), Elan (ELN), and Bristol-Myers Squibb (BMY). Obviously, we're trying to latch on to their long-term potential and ignore what's happening to their earnings here and now.
Recently, we have also gone to the trough of beaten-down cyclicals and have tried our hands at Ford Motor (F), Gap (GSP), Great Lakes Chemical (GLK), and Washington Mutual (WM). Our philosophy here is to take advantage of severely depressed pricing for large-caps and hold them indefinitely, at least through the entire next economic cycle.
We were also very heavy buyers of semiconductors about nine months ago. I'm a believer that that sector will probably rebound before the rest of the techs. Other than that, there aren't a whole lot of screaming buys out there. But I'm a patient lad. I can wait 5 or 10 years for a favorite stock to drop to a nice-enough price.
Q: Do you think WorldCom (WCOM) is headed for bankruptcy?
A: There is so much debris on the balance sheet of WorldCom that it's anybody's guess where it will be in 12 months. If you look at the price of WorldCom bonds, you'll see an inverted yield curve. That is, near-term bonds are yielding much higher than long-term maturities. That means the market is very worried whether WorldCom can make it over the next 18 to 24 months. If it can, the market is resuming smoother sailing. WorldCom has three main major problems -- debt, debt, and more debt.
Q: A morose question -- but will Berkshire crash at the illness or death of Buffett?
A: The premium applying to the shares really reflects the fact that Buffett can redeploy cash flow better than just about anyone on earth. Certainly, nobody will be able to leverage the company's earnings better than he. However, I've got to say that I'm more impressed now than ever with Berkshire's very deep management team. Succession plans are in place, and most of Berkshire's operating businesses have proven that they can run very successfully without Mr. Buffett looking over their shoulders.
Q: Is this a good market for applying the Buffett approach to investing?
A: It's always is a good time to apply his approach. Doing so will save you the embarrassment associated with bear markets and will position your portfolio for the eventual rebound of the stock market.