Markets & Stocks
Buffett sees fewer bargains
March 14, 1998: 2:50 p.m. ET

Billionaire investor says lofty stock prices have eroded margin of safety
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NEW YORK (CNNfn) - Billionaire investor Warren Buffett told shareholders Saturday there are fewer bargains in the market today and rising stock prices have eroded the margin of safety for investors.
     In his annual letter to shareholders, Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., also detailed three non-conventional investments he had made last year -- oil, silver and zero-coupon Treasury securities -- some of which have some Wall Street experts scratching their heads.
     Buffett, one of the world's richest men, has continually outperformed the market by investing for the long term in good companies with solid growth potential. However, he said it is getting harder and harder to find companies that fit that criteria in the current market environment.
     "In the summer of 1979, when equities looked cheap to me, I wrote a 'Forbes' article entitled, 'You pay a very high price in the stock market for a cheery consensus.' At that time skepticism and disappointment prevailed, and my point was that investors should be glad of the fact, since pessimism drives down prices to truly attractive levels," Buffet said in his letter, which was posted on Berkshire's Web page.
     "Now, however, we have a very cheery consensus. That does not necessarily mean this is the wrong time to buy stocks: Corporate America is now earning far more money than it was just a few years ago, and in the presence of lower interest rates, every dollar of earnings becomes more valuable. Today's price levels, though, have materially eroded the 'margin of safety' that Ben Graham identified as the cornerstone of intelligent investing."
     Hugh Johnson, chief investment officer for First Albany, said investors are likely to react "gingerly" on Monday to Buffett's cautious statements about rising stock prices and his big gamble on Treasurys.
     "I think everybody knew this before, but this kind of takes it from the back page and moves it to the front page," Johnson told CNNfn. "He certainly carries a lot of weight in the market."
     In his letter this year, Buffett said prices are high for both businesses and stocks -- and while that does not mean either will fall, the prospective return on investments is likely to be less. With regard to Berkshire, Buffett was a little more specific, telling shareholders the company's rate of progress in both investments and operations is "certain" to fall in the future.
     "For anyone deploying capital, nothing recedes like success." he said.
     During 1997, income from Berkshire's investments rose 33.5 percent, and operating earnings surged 70.3 percent. Buffett said operating earnings were bolstered last year by better-than-expected performance in Berkshire's insurance business, a trend that he said would probably not continue in 1998.
     While Buffett's letter included many of the "Middle America" type explanations about his investing philosophy, his description on non-conventional investments, particularly the Treasury securities, raised a few eyebrows.
     At the end of last year, Berkshire's largest non-traditional position was $4.6 billion of long-term zero-coupon obligations of the U.S. Treasury. These securities pay no interest, but their market prices move rapidly when interest rates change. If rates rise, holders lose heavily with zero coupons, but if rates fall, holders make huge gains. Since rates fell in 1997, Berkshire ended the year with an unrealized pre-tax gain of nearly $600 million.
     However, Johnson said the move is risky if interest rates rise this year, particularly if economic growth continues to forge ahead.
     The analyst said $4.6 billion in zero coupons "is a huge commitment. At least at this juncture, I'm not sure he's made a good choice."
     In his letter, Buffett acknowledged the move poses some risks.
     "In purchasing zeros, rather than staying with cash-equivalents, we risk looking very foolish: A macro-based commitment such as this never has anything close to a 100 percent probability of being successful.
     "However, you pay (Berkshire Vice Chairman Charlie Munger) and me to use our best judgment -- not to avoid embarrassment -- and we will occasionally make an unconventional move when we believe the odds favor it. Try to think kindly of us when we blow one. Along with President Clinton, we will be feeling your pain: The Munger family has more than 90 percent of its net worth in Berkshire and the Buffetts more than 99 percent."
     Buffett said Berkshire also chose to hold positions in derivative contracts for 14 million barrels of oil, and to take a position in the silver market.
     Last year, Berkshire purchased 111.2 million ounces of silver, producing a pretax gain of nearly $95 million in 1997. Berkshire made an additional purchase in 1998 that brought the total silver holdings to 129.7 million ounces. News of the purchase sent silver prices rising earlier this year as word spread that Berkshire controlled nearly one-fifth of the world's supply of silver.
     In a letter to shareholders last month, Buffett said he decided last summer that higher silver prices would be needed in light of shrinking inventories, but he has no current plans for additional purchase or sale of silver.
     Berkshire's major stock holdings remained virtually unchanged in 1997, with the exception of McDonald's Corp. Last year, Berkshire said it had a 4.3 percent stake in McDonald's. But the holding was not included in this year's annual report, suggesting Berkshire sold the stake or reduced it to less than $750 million.
     Buffett did not elaborate on the McDonald's holding, but said he significantly reduced a few holdings that were below the $750 million threshold, in line with modest changes in Berkshire's stock-to-bond ratio. He did not identify the firms below the $750 million threshold, but said Berkshire plans to continue to make changes in its bond-to-stock ratio in 1998.Back to top


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