Buffett on Chinese stocks, sugar and inflation

May 4, 2015

In this issue:
» The most unique shareholder meeting
» Why beware of IPO valuations?
» Is it time to buy in May or...?
» ...and more!

It is for good reason that these Annual General Meetings are unlike any other shareholder meetings in the world. They are called part rock concert part comedy duo act, lasting upto 8 hours! And the people at the helm of affairs, Warren Buffett and Charlie Munger, enthrall a crowd of over 30,000 year after year at this event.

But this year's AGM marked the golden jubilee of Berkshire Hathaway. And interestingly, an estimated thousand Chinese visitors were among more than 40,000 Buffett devotees at the shareholder meet. The spurt in Chinese interest seemingly coincides with Berkshire Hathaway picking up large stakes in Chinese battery and electric car maker BYD and the country's largest oil producer PetroChina, in recent years. The Chinese markets have of course been very volatile and frothy in recent months. But Buffett's replies to his Mandarin speaking fans brought in the kind of clarity that every value investor in any part of the world would seek.

Buffett was asked if it was wise to apply his long-term value-investing philosophy to the volatile Chinese stocks, which have doubled in value over the last six months. The investor feared that the stocks could crash. To that Buffett counseled "I would invest in China or any place else ... and I would apply exactly the same sort of principles".

For anyone who wishes to put Buffett's value investing principles to practice, the Buffett-would buy criteria are the most universally applicable. And whether it is stocks in China or India, the definition of intrinsic value does not change. Hence going by Buffett's comment, his hunt for long term value creating stocks will not stop in the US, Europe or China. As long as he finds well managed companies trading well below intrinsic value, they may be contenders for the Berkshire portfolio in the years to come.

Now his partner Charlie Munger was no less articulate while defending his preference for sustainable businesses. Fielding questions on the love for owning junk food manufacturing companies, Munger jokingly replied "Sugar is an enormously helpful substance. It prevents premature softening of the arteries." Munger explained that the idea behind owning junk food stocks is to own the best brands rather than the best products. Because branded businesses are ultimately profitable businesses.

And how long does the Oracle of Omaha see the bull markets raging? Well Buffett admittedly has been wrong on the Fed action on interest rates so far. And therefore he could hardly hazard a guess on whether inflation and higher interest rates could arrest the market rally. "So far, I have been wrong on interest rates ... It is so hard for me to believe that you can drop money from a helicopter and not have inflation, but we haven't."

On whether the US Market cap to GDP ratio of 125% is sustainable, Buffett responded, "The policymakers have done a lot of things that weren't in my Economics 101 course. So the very low rates changed the usual calculations."

Now these words come from a man, who has over the past half century, grown Berkshire's per share book value by 19.4% annually, resulting in a very impressive total increase of 751,113%. The growth in the firm's stock price at 18,262 times during this period is legendary.

While it is rather ambitious for any investor to try and repeat this feat, the key takeaways from Buffett's letters and Berkshire AGMs over the last 50 years are certainly a treat and a must read for anyone who doubts the applicability of value investing principles across markets and economic cycles.

Which companies' AGMs have you enjoyed attending? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
Over the last couple of months the India stock markets have corrected sharply over concerns pertaining to retrospective taxation, sub-par monsoons, poor earnings expectations etc. And if we go by the past history, more trouble awaits in the month of May. As per a news article, Indian indices have lost ground about 11 times in May since 1993! That is about 50% of the time the Sensex has fallen in the month of May over the last 20 odd years. Not only India even global markets typically tend to lose ground in May. For instance, since 2004, Asian markets (ex- Japan) have declined on 7 occasions in this month. Even European and the US markets have revealed similar tendency. It seems the month of May is a curse for equity investors.

Now Indian investors have had a fairly good run since the elections last May.

Buy in May or Go Away?

The Sensex has returned 20% on a year to date (YTD) basis. To the right of Sensex are 3 top performing sectors, while to its left are the 3 worst performing sectors on YTD basis. Going by the poor earnings announcements and weak sentiments, the stock market performance this month may well be no different than those in the past. But for long term investors, the possible market correction may offer opportunities to pick up stocks that seemed very expensive over the past few months.

You would be already aware of our warnings on the IPO boom in recent months. It is not for nothing that we caution investors during such times. No matter how good a company may be, the price offered to investors is usually too expensive. But there is more to the story. IPOs carry an inherent risk of luring investors into a buying frenzy. If the story is new, the promoters and merchant bankers demand valuations that are insane. All too often it is the retail investor who falls for this trap.

The best example right now can be found in the Indian startup space. The valuations here have already crossed all limits of sanity. The blame was laid at the door of venture capitalists (VCs) until now. However, the flood of cheap money from the US has led to a surprising development. Hedge funds have begun investing in early stage Indian start-ups. In many cases, they have bypassed the VCs and offered more favourable terms to promoters of startups. We don't think there can be surer a sign of a bubble than this. The problem for retail investors is that many of these start ups are headed for Dalal Street. There could be a repeat of the tech boom frenzy of 1999-2000. When such IPOs hit the market, retail investors would do well to remember what happened when that bubble burst.

Buying interest in auto, energy and pharma stocks helped the Indian markets to consolidate gains as the day progressed. At the time of writing, the BSE-Sensex was trading higher by 321 points or 1.2%. Stocks from banking and IT sectors failed to elicit investor interest. Asian markets ended the day on a mixed note. European markets too were trading mixed at the time of writing.

 Today's investing mantra
"Being rational is a moral Imperative. You should never be stupider than you need to be." - Charlie Munger at Berkshire Hathaway 2015 AGM

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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2 Responses to "Buffett on Chinese stocks, sugar and inflation"


May 5, 2015

You have stated definition of Intrinsic value(IV) doesn't change. Calculation of intrinsic value is based on Future cash flow which is subjective. i have seen Intrinsic value of stock varying among various research organisations and even within same organisation as research analysts make their own assumptions for future cashflow and calculation of IV.



May 5, 2015

Would Equitymaster take a cue from Mr.Buffett and provide recommendations for the Chinese market as well in the future?:)

Equitymaster requests your view! Post a comment on "Buffett on Chinese stocks, sugar and inflation". Click here!
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