Geoff Gannon February 22, 2020

Ask Yourself: In What Year Would You Have Hopped Off the Warren Buffett Compounding Train?

Warren Buffett’s annual letter to Berkshire Hathaway shareholders was released today. It starts – as always – with the table comparing the annual percentage change in Berkshire Hathaway with the annual percentage change in the S&P 500 with dividends included. Long time readers of the Buffett letter will remember when the change in book value of Berkshire Hathaway was included. That’s been removed. We are left with the change in per-share market value of Berkshire Hathaway.

Today, I’m just going to focus on this table. Over the next few days, I’ll talk about a few different parts of Buffett’s letter I found interesting. But, one of the most interesting pages in the letter is the very first one. The one with the table showing Berkshire’s performance vs. the S&P 500.

What’s notable about this table? One, Berkshire has outperformed the S&P 500 by about 10% a year over more than 50 years (1965-2019). Berkshire has compounded its market value at about 20% a year while the S&P 500 has done 10% a year. What’s also notable is the many very big years for Berkshire as a stock. On my print out of the letter, I circled some years that stood out to me. Basically, I just assumed that it’s incredibly rare for the S&P 500 to ever have a return of around 50% a year. Generally, an amazing year for the S&P 50 would be one like what we saw last year (up something over 30%). If you are completely in the S&P 500 index, your portfolio is not going to have up years of 40%, 60%, or 120%. Berkshire’s stock price sometimes does go up that much. Or, rather – it sometimes did. It hasn’t lately.

Berkshire had amazing up years – as a stock, these don’t necessarily match up with business results – two times in the 1960s, three times in the 1970s, three times in the 1980s, twice in the 1990s and then never again since the late 1990s. Berkshire’s stock has gone over 20 years with no what I’d call amazing up years. Any good year Berkshire has had as a stock in the last 20 years has been the kind of up year an index like the S&P 500 is also capable of. This obviously tamps down on Berkshire’s long-term performance potential. Most stocks that have amazing long-term compounding records will achieve those records with a bunch of short-term upward spurts in their stock price like Berkshire had in the 1970s, 1980s, and 1990s. In the last 20 years, Berkshire has had several years where returns were in the 22-33% range. Those are great years. But, they are years the S&P 500 is also capable of having (it was up 32% last year). The disappearance of these very big up years – the “lumpy” outperformance – in Berkshire as a stock explains a lot of why the stock performed so well versus the S&P 500 for its first 30 years under Buffett and so much less well over the last 20 years.

I also wanted to focus your attention on this table to consider whether you would have really held Berkshire Hathaway stock through the 1970s, 1980s, and 1990s. It hasn’t been hard to hold Berkshire stock these last 20 years. The stock hasn’t had many huge up years or huge down years. It would be easy to convince yourself the stock was always within spitting distance of fair value and you might as well hold on. But, we need to remember that Berkshire’s outperformance over 50+ years is much more weighted to the 1960s, 1970s, 1980s, and 1990s.

Berkshire’s stock rose 50% in 1965 (around the time Buffett was taking over the company). It was basically a poorly performing (but not terribly small) net-net focused on textiles. It now had a successful hedge fund manager in control of the board. So, a 50% increase in the stock price would’ve meant the stock was still crazy cheap and now you had a great catalyst. Okay. You may have held on from there. It rose another 78% in 1968. At this point, would you have held the stock or “taken profits” in this underperforming textile company. Remember, Berkshire was still overwhelmingly in textiles in 1968. Now, it’s possible you might have held. I know plenty of investors who hang on to a stock they like even after a 78% gain in one year. Though I probably know more that like to trim back such a position – especially if it started as an oversized holding for them – and “take money off the table”. If something doubles, they like to sell about half of it and “play with house money”. Still, stocks weren’t that cheap in 1968. Berkshire was already performing well as a stock compared to a lot of the other stuff that might’ve been in your portfolio from 1965-1968. It was not expensive. Buffett was clearly doing stuff with it. He had an amazing record as a hedge fund manager in the 1950s and 1960s. And, in 1967, he bought an insurance company in the city where he lived (Omaha). So, there was a really clear catalyst here where a star hedge fund manager was shifting a New England based net-net away from its bad textile business and into an Omaha based insurance business. Insurers control money. They make investments. Even if you didn’t know Buffett had a history investing in GEICO personally – and I’m pretty sure you wouldn’t have known that in 1968 – you still would’ve known insurers have an investment side and an underwriting side. Buffett already had a record as one of the best investors in the U.S. He was young. He was already improving capital allocation at Berkshire. Would a deep value investor have held at this point? No. He’d have sold out. But, someone who believed in Buffett? Yes. He might have stuck with this stock into the 1970s – which is where I see the first years that would’ve gotten a lot of value investors out of this stock.

Berkshire had one terrible year in the 1970s. In 1974, the stock plunged 49%. The S&P 500 was down over 40% during 1973 and 1974. If you look at calendar year results – Berkshire badly underperformed the market in 1974. But, my guess is that Berkshire’s decline in the 1973-1974 period (a terrible one for many stocks) was about equal to what you would’ve seen in other stocks in your portfolio. There’s no reason to think you would’ve seen this as a big buying opportunity in Berkshire – or, as a sign you needed to dump the stock. A lot of investors were dumping a lot of stocks. But, the decline in Berkshire in 1973 and 1974 would’ve been pretty typical of what you might’ve seen across the board in your brokerage statements. Remember, Berkshire was not a big stock at this point. It wasn’t all that widely traded. Also, stocks in general were much less frequently traded in the early 1970s than they are today. NYSE listed stocks in the 1970s and 1980s probably turned over at a rate you now see only in fairly illiquid OTC type stocks. So, you should keep in mind that when we’re talking about the first 20 years of Buffett’s record at Berkshire (from 1965-1985) we’re talking about a period of generally falling interest in stocks among the public, low share turnover, etc. A lot of these were pretty pessimistic years in terms of people’s expectations for stocks. That was not true right around the start of the period (1965 and earlier) and wouldn’t be true again once we get out of those first 20 years (1985-2000). A lot – but certainly not all – of Buffett’s great compound record is due to these 20 years from 1965 to 1985 where people were generally getting less interested in and more pessimistic about stocks.

It’s not the down years in the 1970s that worry me. It’s the up years. This is what would’ve shaken out a lot of the best investors I know today. Value investors have a tendency to sell their winners. And Berkshire was a bigger winner several times in the 1970s. Would you have sold out – or, more likely, trimmed back your position to a “prudent level for diversification purposes” – in years like 1971 (up 81%), 1976 (up 130%), or 1979 (up 103%).

Those years are the kind of years that tend to weed out the value investors among a shareholder base. Berkshire’s compounding record – in stock market value, not book value – wasn’t all that smooth. There are strings of strong but steady results. I think investors would’ve enjoyed the years 1980, 1981, and 1982 for example. The stock was up 33%, 31%, and then 38% in those 3 years. In my experience, investors love annual returns in the 30% range. If you buy a stock and it goes up 120-175% in one year – you usually sell. But: if that same stock goes up 30-40% in year 1, 30-40% in year 2, and 30-40% in year 3 – you’re a lot more likely to stick with the stock if it’s your favorite business run by your favorite CEO. By the early 1980s, Berkshire was also looking a lot more like a business that would be comfortable to hold. Buffett had successfully diversified the company away from textiles – to the point where the New England mills barely mattered. In 1980, you would’ve already read Berkshire’s 1979 annual report. You would’ve known Berkshire was getting most of its earnings from insurance – not from textiles. It was like 50/50 an insurer slash investment portfolio and the other 50% a group of owned businesses. The biggest of these owned businesses was an excellent bank in Illinois. The second biggest was a very successful candy company in California. Then there was a mix of mostly other financial type companies. In fact, by 1980 – you could’ve expected Berkshire would become mostly some sort of financial company. It did have a big (loss making) investment in a Buffalo newspaper and a minority position in the Washington Post and some other media properties. So, you would’ve realized Buffett liked media companies. But, he seemed to like insurers and banks at least as much. I don’t think the steady returns throughout the early 1980s would’ve been a problem.

But, even in the later 1980s we see some pretty big one year gains. In 1983, Berkshire rose 69% vs. 22% for the market. Then 94% versus 32% for the market in 1985. The really tough time to keep holding Berkshire would’ve been the end of the 1980s. Berkshire was up 59% in 1988 and 85% in 1989. It then plunged 23% in 1990.

After that, it got relatively easy to hold Berkshire Hathaway. Buffett was a pretty well known person – at least among investors in the know – by 1991. He was kind of famous from this point on. Not as famous as he’d become as an old man. But, famous enough that he was as well known as anyone in the investment world. Berkshire rarely had huge up or down years after 1990. It did rise 50% or more twice in the 1990s. But, so did a lot of stocks. These were amazing years for the overall market. Berkshire was more of a value stock than the other things you could’ve bought. I don’t see a lot of value investors who stayed plain vanilla value investors – instead of getting into the dot com stuff – being likely to hop off Buffett’s compounding train anytime in the last 30 years.

What were the tough years?

For value investors, I think there were several years in the 1970s and 1980s that would’ve really tested their willingness to hang on to an amazing winner. Berkshire wasn’t a hot stock ever. But, it did have some good years in the 1970s when some other stocks were insanely cheap. To be fair, getting off the Berkshire compounding train at this point and into one of these other super cheap stocks wouldn’t have been as dumb a move as it seems to us now. Berkshire even owned some of the stocks I think value investors would’ve been tempted to get out of Berkshire for. A good example would be ad agencies. Other examples would be leading big city newspapers. Berkshire bought into both type of stocks in the 1970s and had great results. And remember: Berkshire paid no dividend – while a lot of these great ad agencies, newspapers, etc. had dividend yields of 6-10% a year at the market’s bottom. So, a lot of investors would’ve abandoned a company with a dividend yield of nothing for one with a nearly double-digit yield. And these Investors abandoning Berkshire for some of those same shares Buffett was buying in the 1970s would’ve gotten some good compound results too.


Would they have ever gotten back into Berkshire?

That’s the problem.

In any decade, we can find a few stand out stocks in a few stand out industries that would’ve compounded like Berkshire. But, how many of the winners of the late 1960s were the winners of the 1970s? How many of the winners of the 1970s were the winners of the 1980s? And so on. Part of Berkshire’s success came from the fact it had a really good 1965-1972 period (especially versus other stocks) AND a really good 1985-1992 period. I can’t think of many businesses that were still that good at compounding 20 years later. The best returning stocks from 2010-2019 are very unlikely to be the best returning stocks again from 2030-2039. We’ll have forgotten the names of many of the market’s winners over these last 10 years by the time the 2030s end.

So, when would you have gotten off the Berkshire Hathaway compounding train?

When would you have taken profits, trimmed back your position to a manageable size, gotten out entirely?

And would you have ever gotten back in?

Learning from Buffett’s success as an investor has two parts. One, you need to know how he compounded like he did and try to copy what you can. Two, you need to know how to let a successful investment – once found – compound for you for as long as he has.

I’m sure I never would’ve stayed in Berkshire stock till 2020 if I’d bought it in 1965. I’m less sure of where I would’ve sold out, why, and if I’d ever get back in.

Try the thought experiment on yourself at home. Imagine you bought Berkshire in 1965. Which specific years would’ve most tested your resolve to keep betting on Buffett. Would it have been a mistake to sell? And, what can you from this little bit of self-discovery about your approach to buy and hold?

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