Newsletter March 1, 2009

InvestorsFriend Inc. Newsletter March 1, 2009

Warren Buffett’s Annual letter

Each year Warren Buffett issues a shareholder letter of about 20 pages. This is directed mainly at Berkshire Hathaway shareholders. But it has increasingly become a “must read” document for anyone interested in stock investing. When the world’s most successful investor, and one of the greatest financial minds ever, speaks, smart investors listen.

Some would argue that Buffett has lost his touch. After all, Berkshire Hathaway shares have fallen about 50% from their late 2007 peak. But the fall in Berkshire’s book value per share in 2008 was only 9.6%. The stock market can at times be irrationally exuberant and at other times irrationally pessimistic. Buffett knows that if he keeps growing the true value of Berkshire on a per share basis, the stock price will do well over time. Despite the 50% fall in its stock price, Berkshire is still up about a staggering 1 million percent from the $7 or $8 range that it was at when Buffett starting buying it in 1962. The book value per share of Berkshire is up 362,319% since the start of its 1965 fiscal year. Buffett took control of the company in 1965.

You could do yourself a favor and add to your investing knowledge by reading closely his latest newsletter. You can access it here.

When you finish this latest letter, and if you are serious about gaining investment knowledge do yourself a HUGE favor and read all of his letters since 1977 which are available here:

Much of the advice in the old letters is timeless and even the history of how Berkshire was built up over the years is worth reading in itself.

Is Stock Investing Rewarding? Is Buy and Hold Dead?

The Standard and Poors 500 index is down 53% since its highest close ever of 1565 reached on October 9, 2007. The Toronto Stock exchange is down 46% since its record close of 15,073 reached 8 months ago on June 18, 2008.

(Editors note this next paragraph was corrected on March 28, 2009, it originally had the return per year indicated rather than the cumulative return as intended)

Worse than that, the S&P 500 index is down an even 50%!!! since the end of 1999. And the TSX index is down 4% over that period. That is a pathetic result for over nine years of investing. Investors in the index would also have received dividends of around 2% per year. But overall in the past nine years the return on the S&P 500 has been a LOSS of around 5.3% compounded per year (before fees and taxes) while the TSX index gained about 1.5% compounded per year and that is completely pathetic.

In recent months Stock exchange indexes are down massively all over the world. The reputation of stocks as being rewarding even in the long-term investment has taken a beating. The reputation of capitalism and free markets as the best system to raise human living stands has itself taken a huge beating.

But do the last nine years and particularly the last few months prove that Buy and Hold Dead? Many analysts believe that the lesson of this recent market crash is indeed that “buy and hold” is a failed strategy. These analysts believe that the only way to make money in stocks is through trading strategies.

It is certainly true that the best traders have done better than buy and hold. In some cases massively better. It is less clear if there any proven trading strategies that are certain to out-perform in the long run.

Consider the following mathematical facts:

By definition the average stock investor makes a return before fees and taxes that is equal to the market return.

Buy and hold investors who hold the market average portfolio, such as through a market index fund, all make a return (before fees and taxes) equal to the market average. (Not just on average, all of them).

Mathematically the return of all other strategies (rapid trading, market timing, value investing) must also on average be the market return (before fees and costs).

Now consider that all strategies other than buy and hold will involve higher trading fees and (unless in a tax-free account) higher taxes as gains are realized rather than deferred.

The indisputable conclusion is that if Buy and Hold is dead this means that the average across all other strategies is even more dead since they face higher fees and taxes. Some will win with these other strategies, but on average they will do worse than buying and holding the market average.

This does not prove that there are not some strategies better than buy and hold. Maybe there are although they have to overcome higher fees and taxes. I like to think that buying stocks that appear to be high quality and under-valued can beat the market index. So far that has worked for me. But if I though that Buy and Hold was really dead I would conclude that stock investing, using any strategy I know of, is too dangerous.

If Buy and Hold is dead then we are essentially saying that the stock market on average will provide little or no return in the long-term. This is equivalent to saying that owning a share of “corporate America” or “corporate Canada” will not be a profitable venture in the long term. That can only happen if businesses are going to stop making profits and will make little or no profit in the future. Unless we are headed for a complete break-down of society, that just does not make sense.

I don’t do my investing by playing  Casinos games since I KNOW that is a losing game. I believe it is mathematically and logically obvious that stock investing is a winning game on average over the long term. On top of the favorable wind of playing a winning game (buying and holding a diversified portfolio of stocks) I try to layer on superior stock selection based on value analysis. If I thought that that buy and hold was a losing strategy (I don’t think that) then it would be hard to justify trying to win (through value investing) at what would then be effectively a losing game, like casino games).

I recently updated a couple of articles that look at returns from the stock market in the past. The picture has worsened due to the crash in stock prices in 2008. Nevertheless, the data still show that stocks have been a good investment in the long-term.

Updated Articles

Click to see our updated article on annual stock returns year by year since 1926 up to the end of February 2009.

Also our updated Article on whether Stocks are really riskier than Bonds (updated for 2008 data) Also see our February 20 update of  our calculation of the fair value of the S&P 500 index

Investment Outlook

All indications are that the recession is deepening. Job losses will continue to mount. Profits are still declining. International Trade is declining.

But does that mean stocks will keep declining? Well, they might or they might start gaining in spite of a deeper recession.

Consider that the TSX market peaked last June. And the S&P 500 index peaked in late 2007. The whole sub-prime crisis was was well under way by mid-2007. The Asset Backed Commercial Paper fiasco developed in August 2007. But markets continued for a time to perform very well despite early signs of recession and despite the sub-prime mortgage situation. It was only in September 2008 that the market began to crash viciously.

The point is that markets sometimes diverge away from what is happening in the economy. The Market at first failed to “notice” that the real economy was slowing. (I pointed out in September 2007, that it seemed like the market was refusing to be beaten down despite many negatives). Then when the market finally noticed the recession, it crashed by about 50%. This is far worse than the crash in the real economy (at least so far). At some point when the market starts to recover, it could similarly rise very rapidly.

No ones knows if stocks will continue to go down. But it does seem that many stocks and corporate bonds are at very attractive levels. Buying now is likely to work out well in the long-run.

Individual Stock Picks

Those of you who are not yet or not currently subscribers to our Stock Research service can see a description of this here.


Shawn Allen, President
InvestorsFriend Inc.

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