Warren Buffett's attitude when he has lots of cash but shares seem expensive

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We can learn a lot from the way Warren Buffett behaved when the stock market was bounding ahead in a burst of enthusiasm.  Even though the story takes place over 30 years ago it is highly relevant for where we are today.  In the mid-1980s Berkshire’s controlled subsidiaries and security investments were bringing in hundreds of millions of dollars for Buffett and Munger to invest – see Table 1.

Table 1. Net earnings after taxes attributable to Berkshire Hathaway from operating businesses

$m   1985   1986   1987
Insurance underwriting -23.6 -29.9 -20.7
Insurance investment income (dividends and interest) 79.7 96.4 136.7
Realised security gains 325.2 150.9 19.8
Buffalo News 14.6 16.9 21.3
Fechheimer 3.8 6.6
Kirby 10.5 12.9
Nebraska Furniture Mart 5.2 7.2 7.6
Scott Fetzer Mfg. Group 0 13.4 17.6
See’s Candies 14.6 15.2 17.4
Wesco – other than Insurance 9.7 5.6 5.0
World Book 11.7 15.1
Other 19.9 -4.9 4.3
Interest on debt -7.3 -12.2 -5.9
Charity donations by BH shareholders   -2.2   -2.2   -3.0
TOTAL EARNINGS 435.8 282.4 234.6

(Source: Warren Buffett’s Letters to Berkshire Hathaway shareholders 1986-87)

But there was a problem for any value investor at that time: the stock market had been zooming away.  The Dow, a mere 800 in the early 1980s, more than tripled in five years to reach 2,709 in August 1987 – see Figure 1.

Figure 1. Dow Jones Industrial Average January 1980 – August 1987

The shape of the Dow curve is remarkably similar to the last seven years – see Figure 2.

Figure 2.  Dow Jones Industrial Average 2012-2019

Investors had been so pessimistic in 1980 and 1981 that they priced the typical American share at a mere 7 – 9 times the previous years’ earnings.  Then, as recession was put behind them, companies and shareholders gradually grew in confidence, and PERs rose to double figures – see Figure 3.

Figure 3.  S&P 500 price earnings ratio, 1980 – 90

Things started to get out of hand in 1986, and by August 1987 US shares we

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