In his letter to the shareholders of Berkshire Hathaway, dated 27 February 2009, Warren Buffett revealed the per-share book value of their stock had fallen by 9.8% in a year. The S&P 500, including dividends, was down 37%. Was the oracle of Omaha panicking and liquidating his portfolio? No.
Stock markets usually go up
The 2009 letter shows a table of the annual performance of the S&P 500 from 1965 to 2008. In three-quarters of those years, a gain was made. Warren Buffett surmised that a similar proportion of the next 44 years would also be positive. However, he stressed that he cannot predict which years will be winners and which will be losers in advance. Therefore, when times are good or bad in the markets, he and his partner, Charlie Munger, focus on four goals for their portfolio:
- Buy quality stocks with good liquidity and solvency positions that generate plenty of cash
- Invest in businesses that have and can maintain a competitive advantage, i.e., they have a “moat”
- Find businesses with outstanding management teams, develop and support them
- Keep buying quality stocks of businesses with competitive advantages with great management behind them when they are available for a great price
This investment approach does not change whether the market is up or down. What does change is the number of stocks available for a great price.
Mr Market
The 1987 letter to the Shareholders of Berkshire Hathaway references a story told by Warren Buffett’s friend and mentor, Benjamin Graham. Mr Market is a capricious fellow. He turns up every day to offer to buy and sell stocks to you. Sometimes he quotes wildly high prices, sometimes, his mood is low, and he quotes rock-bottom prices. His prices often don’t seem to chime with the quality of what he is selling or buying. The trick is to realise that Mr Market can be sent away without transacting with him.
An investor needs not to be led by Mr Market’s ticker tape. Investors should determine a price they would be happy to buy a quality, comparatively advantaged stock with great management. If Mr Market turns up one day and offers to sell such a company below that price, he will get his hand bitten off, and if not, well, Mr Market will be back tomorrow.
Warren Buffett is greedy…sometimes
The most famous quote from one of the world’s greatest investors is probably:
Be fearful when others are greedy, and greedy when others are fearful.
Warren Buffet, Berkshire Hathaway, Inc. Chairman’s Letter, 1986
This quote means that the time to load up and greedily feast on stocks in fantastic businesses is exactly when others are panicking, and the market is tanking. That is when Mr Market is likely to offer prices below a business’s intrinsic price, which is calculated based on its long-term potential.
So, Warren Buffett probably does not do anything different when the market is crashing compared to when it is booming. But he might do a little more. That’s because market crashes are an opportunity to buy stocks he wants to own for a lower price.