Thursday, November 12, 2009

Warren Buffett and the Business of Life: Part 3 of 7

Buffett had long preferred to find a great company and own the stock as long as possible. Investors who had watched him over the years had become so accustomed to certain Buffettisms--holding stocks for the equivalent of an investing lifetime, not selling businesses that Berkshire acquired, investing as though there were only twenty punches on your scorecard--that they believed Buffett's investing style was to buy and hold forever.

Buffett had indeed learned through experience that "when in doubt keep holding"; he said, "I've made most of my money sitting on my ass." He never sold failing businesses unless their economics turned from simply bad to parasitic, for personal reasons: He liked the people, the managers, the business, the simplicity of fewer decisions, and the reputation for loyalty.

Yet during his early, hungry years, he had not hesitated to sell one stock for another when a better opportunity came along. During the 1960s bubble, he moved money into staid AT&T, then shut down his investing partnership completely to protect his partners (and himself) from financial harm. During the 1987 bubble, with no partnership to liquidate and so much capital it had become a struggle to manage, he dumped many stocks in favor of bonds and pared the portfolio--but kept what he called the Inevitables (GEICO, Cap Cities, and the Washington Post). Still, by selling stocks, he had at least partly protected his shareholders from the second major market crash of his lifetime.10

In the 1990s, more passivity crept into his investing style. By then, Berkshire had far more money than it could use. During the Internet bubble, rather than sell overvalued stocks such as Coca-Cola (another of his Inevitables), Buffett diluted the risk from these stocks to Berkshire's balance sheet by acquiring General Re.

With hindsight, he did say his failure to unload some of those stocks was a mistake. He explained that his role as a board member had gotten in the way of his selling Coca-Cola. Buffett finally stepped down from the board in February 2006, avoiding another referendum on his independence as a board member. Privately, Munger complained that Buffett should have resigned from the Coca-Cola board earlier so that they could have sold the stock. Selling would have pushed down the price, but not by as much as it eventually declined.

"I always used to tell Gates that a ham sandwich could run Coca-Cola. And it was a damn good thing, too, because we had a period there a couple of years ago where, if it hadn't been that great of a business, it might not have survived."

The company--and its stock--did rebound. By 2008, most of its business problems had been largely resolved, and CEO Neville Isdell, who announced his retirement in 2007, had settled the Justice Department investigation and closed a $200 million racial discrimination lawsuit. The new CEO, Muhtar Kent, had led the company's successful push into non-cola drinks, where Coca-Cola had been lagging and was strategically off course.

Still, as of early 2008, Coca-Cola's stock price, at $58, was fifty-six percent above its lowest price, but did not approach its pre-bubble high of more than $87 per share, and couldn't justify Berkshire's having held the stock for a decade. And it would soon turn out that Coca-Cola's stock price was tracking the overall stock market, which would be revealed as part of another speculative bubble, this one buoyed by the ebullient "consumer economy" and driven by cheap credit. Although average wages in the United States had risen only 0.6 percent a year since 1998 and consumer confidence had been declining steadily, GDP had risen 2.6 percent a year. This was an artificial increase--boosted by an $8.6 trillion increase in personal indebtedness and an almost $20 trillion increase in household net worth--that came from rising real estate values and the stock market. In essence, consumer debt had inflated the economy beyond its real size. This economic "growth" was simply borrowed from the future, and would have to be paid back with interest.