Recs
By Alex Dumortier | More Articles February 14, 2012 | Comments (21)
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Last Thursday, Berkshire Hathaway (NYSE: BRK-B ) Chairman Warren Buffett published "Why stocks beat gold and bonds," an adapted excerpt from his upcoming shareholder letter. There is little to disagree with in the letter, but Buffett's exposition is a bit misleading, or at the very least, incomplete because he isn't explicit enough in spelling out his assumptions. Investors who follow his advice blindly, without understanding those assumptions, could achieve a very different result from the one Buffett describes.
The crux of Buffett's argument is that stocks will beat gold and bonds because, unlike the latter, they're a productive asset, i.e., a good-quality business like farmland or rental property that provides a product or service on a recurring basis that people will be willing to pay for. That's true, as far as it goes, but it's not enough.
Valuation mattersConsidering that he is arguably the greatest value investor of all time, it's odd that Buffett doesn't make more of the impact of valuations on the expected performance of different asset classes.
Consider, for example, that over the 10-year period from 2002 through 2011, the S&P 500 managed to produce an annualized return, after inflation, of just 0.4%. Meanwhile, the equivalent figure for gold is a whopping 15.8%! U.S. stocks barely kept pace with inflation -- did the productive capacity of top U.S. corporations collapse during that decade? Of course not -- just look at the earnings growth data for the S&P 500 along with four high-quality businesses that Berkshire owns (Buffett refers to two of them, ExxonMobil and Coca-Cola, in his article):
Company
10-Year Real Earnings-per-Share Growth (annual)
2002-2011
10-Year Total Real Return (annual)
2002-2011
Coca-Cola (NYSE: KO )
6.1%
1.5%
ExxonMobil (NYSE: XOM )
11.8%
5.4%
Procter & Gamble (NYSE: PG )
9.6%
2.8%
Wells Fargo (NYSE: WFC )
8.4%
(0.1%)
S&P 500
10.8%
0.4%
Gold
0%
15.8%
Source: Capital IQ, Kitco, Robert Shiller, author's calculations.
In each case, the individual companies and the S&P 500 generated earnings growth well in excess of their total stock return -- and that doesn't even account for the income return from dividends! Clearly, there's something else going on here; the answer is contained in the following table:
Company
Beginning-of-Period P/E Ratio (Dec. 3, 2001)
End-of-Period P/E Ratio (Dec. 31, 2011)
10-year P/E growth
Coca-Cola
29.5
19.0
(4.3%)
ExxonMobil
18.2
10.1
(5.7%)
Procter & Gamble
37.3
19.6
(6.2%)
Wells Fargo
22.1
9.8
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