The view from Omaha - Warren Buffett style
With the Dow Jones industrial and the Nasdaq composite experiencing huge daily volatility, this column will attempt to explain the philosophy of Warren Buffett and his investor theory on stock valuation.
Berkshire Hathaway's annual report arrived at the house the other day. What Warren Buffett has to say about the current stock market and its valuation is interesting.
Despite the carnage in the market over the past several months, Buffett feels the long-term prospect for equities is "far from exciting." Even his own holdings are mildly attractive and fully priced.
Berkshire's holdings consist of more than $1 billion in each of the following stocks: American Express, Coca-Cola, Gillette, Washington Post and Wells Fargo. (Note: no high-tech equities in his portfolio.)
The per share book value of Berkshire Hathaway outpaced the performance of the S&P 500 in 2000, and the book value has increased from $19 to $40,442 over the years.
Buffett has not invested in high-tech industry because the valuation is not there. Dividend yield, price-earnings ratios, and growth rates have nothing to do with valuation except in providing clues to the timing and amount of cash flow.
Buffett points out that for all the talk of "creating value" during the Internet boom, much of the activity was just transferring value on a massive scale. "By shameless merchandising, promoters moved billions of dollars from the pockets of the public to their own purses and now the company value is in shambles."
Buffett, even before the bubble collapsed, pointed out how silly valuations were becoming. However, most investors, deep down, probably knew this as well, but couldn't force themselves to leave the party. The unrealistic expectation - the apex of greed - should have been a clear sign of trouble.
After being scorned by investors as a doddering old-timer who didn't understand the new investing paradigm, Warren Buffett has reclaimed his title of "Investing Legend."
He regards a strong cash flow, a dominant market share and a superb return on equity as being vital. He cautions investors to ignore the daily - even month ly - price blips of a stock and try to determine if management is building value for the long haul. Finally, he urges investors to seek top-quality management and pay attention to the price of the stock.
As a suggestion, Buffett should look at Washington Mutual because it meets his criteria. Originally Palo Alto Savings and Loan, then Northern California Savings, Great Western Savings and now, the company is Washington Mutual (WM).
WM, the nation's largest savings-and-loan institution and the second-largest mortgage originator, has a branch office at Third and Main streets in Los Altos.
Each time the Federal Reserve lowers interest rates, mortgage rates fall leading to refinancing activity. Two-thirds of WM's revenue is generated from the net interest margin.
Priced at 52 with a 2.53 percent yield, WM is attractively priced for purchase and unless the California real estate market collapses, is a defensive equity most investors could like.
Noel, a seasoned investor, covers the stock market for the Town Crier.