What do value investors do when markets have been lifted high? Warren Buffett's views

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Buffett, in the late 1990s, faced a dilemma common to all investors from time to time (perhaps with smaller sums): he had money to invest, billions in cash or near cash, but “prices were high for both businesses and stocks” (Warren Buffett wrote in his 1997 letter to shareholders).

What to do?

First, he was not interested in selling companies such as See’s Candies or stakes in world-beating companies such as Coca-Cola or Washington Post, saying he was delighted with what Berkshire owned. Beside which he had made commitments to the company leaders that he would not sell them on.

Second, he did not act on the basis of a prediction of a market fall: “we have absolutely no view on that matter” (1997 letter).

That left the great difficulty of a buying at a time when Berkshire would “get relatively little in prospective earnings when we commit fresh money”.

The Dow Jones Industrial Average 1988 – 2001

Let the balls go by

Such times call for extreme discipline.  Buffett used a baseball metaphor to explain the level of self-control required: “we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his “best” cell, he knew, would allow him to bat .400; reaching for balls in his “worst” spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors.” (1997 Letter)

In this period Buffett was seeing business “pitches”, but most just weren’t in the strike zone at all. The few that were headed for the “lower outside corner” were not all that attractive. Swinging at these would lead to Berkshire being locked into low returns.

Unlike a baseball player, investors can’t be called out if they resist three pitches that are at the extremes of the strike zone. They can let ball after ball fly by.

For Berkshire this means the cash flowing from its operating businesses, insurance float and dividends from minority stakes in American giants like Disney would just pile up or be put into Treasury bills.

But, as Buffett says, “just standing there, day after day, with my bat on my shoulder is not my idea of fun”, even if it is the right thing to do.

Your time will come

To cheer yourself up at moments like these it is important to bear in mind that the time will come – maybe soon – when there again is a plethora of fat pitches, just as they did for Buffett in the 1970s and 1980s, and then again after the dot-com crash (2000-2002), and the financial crisis of 2009.  These are the bonanza periods, because low prices mean the long-term investor can lock in future cash flows cheaply while ignoring short-term market worries and fluctuations.

Don’t go with a cheery consensus

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