Buffett the Bondsman

800px-warren_buffett_ku_visitMuch ado has been made recently about Buffett’s buying. A little over two years ago (as of Dec 31, 2006), Berkshire Hathaway held over 43 billion in cash and equivalents. Just in the last year, Berkshire has played banker to the tune of $21 billion. I say banker because this $21 billion went solely to the purchase of fixed income instruments and preferred stock–$400 million for Vulcan, $300 million for Harley Davidson, $150 million to Sealed Air, $5 billion to Goldman Sachs, $3 billion to General Electric, $6.5 billion to Wrigley, $3 billion to Dow Chemical, $2.6 billion to Swiss Re, and now, $250 million to Tiffany’s.

So, it’s clear, Buffett’s been buying. And we know that he is even buying American equities in his personal portfolio, for the first time in many years.

But where has he done most of his buying? Until we see the latest 13F, we can’t say for sure. But right now, it looks like most of his purchases have not been in common stocks, but in bonds, convertible bonds, and preferred stock. Of course, for many of these stock deals, Buffett also negotiated conversion rights or warrants for the purchase of common stock. However, it is very intriguing to me that Buffett has not purchased more equities outright.

Seeing this, I am of two minds. I have seen the values of common stocks plummet to lows not seen in my lifetime, and I feel compelled to take advantage. I also see the world’s most successful investor demanding more security for his investment dollars than merely a low-priced common stock. Perhaps my perceived advantage is not as great as I surmise.

Most simply, we can interpret Buffett’s purchases in one of two ways. On the one hand, perhaps Buffett doesn’t see common equities as cheap enough at these levels (i.e., they cost more than their intrinsic value). Or, on the other hand, Buffett is merely being opportunistic–asking for the extra margin of safety merely because he can get it in this environment. On this view, the common stocks of Harley Davidson and Tiffany’s may be cheap enough for an adequate margin of safety, but the savvy investor capitalizes on the opportunity by demanding an even greater one.

All told, stocks look cheap, and many value investors are seemingly buying with abandon. Yet, Mr. Buffett’s actions give me pause. Are stocks really cheap enough? If not, then I may need to raise my standards.

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6 responses to “Buffett the Bondsman

  1. I am fairly certain that Buffet is being opportunistic. The fact that he is Buffet gives him the option of converting into preferreds etc. I don’t think a common investor can ever get Buffet’s deals. So to me – now seems a good time to start buying.

  2. I agree–Buffett will get deals that I cannot, and that is one of the big draws for owning Berkshire.

    I just have the lingering worry that maybe I should be upping my return threshold for purchases. For example, instead of using a discount rate of 15% with a 25% margin of safety, perhaps a 15% discount rate with a 40-50% margin, or a 20% rate with 25% margin.

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  5. I think you are correct that you should be upping your return threshold for purchases, not because the risks inherent in stocks have increased but because you can afford to be more selective when more opportunities become available.

    Back in 2007, I was happy to find a purchase that looked like it could give me 15% compounded annually, but since mid-2008 I’m looking for 25%+, simply because they’re easier to find.

    On Buffett, I think it’s hard to turn down guaranteed risk-free 10-15% annual returns plus free conversion privileges. If I had that option, I’d be investing in convertible bonds and preferred as well…

  6. My post for tomorrow takes inspiration from Buffett’s 1981 Letter to shareholders. There he talks about the relative value of stocks in an economy with high inflation and 14% tax-free bonds. Most businesses, Buffett concludes, provide no added value for the incremental capital they consume.

    So, yeah, I definitely feel confirmed in upping my equity return requirements in this environment with attractive corporate bond and preferred stock rates.

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