31 March 2013

In Which a Mere Blogger Questions Warren Buffet's Investing Philosophy

Value-investing was developed during the Great Depression. Since then, the percentage of households holding stocks has at least tripled, radically increasing demand for stocks. Because of that, it is too hard to find under-priced stocks to ever systemically apply value-investing. It might be akin to a high school kid holding out for a Sports Illustrated swimsuit model for a prom date. If he can do it, great. But if he wants to go to prom, he might want to lower his standards. So it is for folks who want to retire.

There. That's the gist of my argument. You can click on to another of the web's nearly 15 billion pages or you can read further.

First the caveat. I'm no Warren Buffet. Thursday of last week, Buffet's net worth rose $557 million. Yeah. Half a billion. My total net worth is a rounding error in the amount his wealth fluctuates during a trip to the bathroom. Buffet recommends value-investing, so you would probably be wise to ignore my concerns and listen to him instead.

But you're still here. Good. That means you've got an open mind. So for you I'll elaborate.

Ben Graham and David Dodd developed their ideas about value investing in 1928 and then released a textbook defining it (Security Analysis) in 1934. In its simplest form, the idea is to find stocks that are under-priced and then buy those when investing. Buffet has since defined this as buying outstanding stocks at sensible prices. I'm not foolish enough to argue with this. While it's a great ideal, it's just not a practical idea. Not anymore.

Both the percentage of households owning stock and the percentage of wealth represented by this stock ownership have gone up dramatically since Graham and Dodd wrote their book. As demand has risen for stocks, it is harder to find under-priced stocks that meet their criteria. While you wait for cheap stocks, you could miss out on decades of decent gains.

In 1929, when the stock market crashed and triggered the Great Depression, only twenty-some percent of Americans owned stock.

Gallup reveals that about 54% to 67% of households now hold stock. This percentage probably under-reports the actual percentage since so many Americans are invested in the stock market through pension funds they're unaware hold stocks.

Further, the portion of household wealth has gone up. In 1984, only 9% of household wealth was in the form of stocks (either directly or through mutual funds or IRA accounts). By 2011, that had risen to 46%. (401(k) accounts did not take off until about 1984.) As a percentage of household wealth, stocks rose about 5X in a quarter century.

This demand for stocks has driven up their price. And it is only getting worse. It's a cliche (and possibly even accurate) to say that about 20 years ago 80% of retirees depended on fixed pensions whereas today it is 80% of retirees who depend on their own investments. Demand is high for stocks and that alone drives up prices.

So, if you can find a stock that sells for cheap, a stock that's a great investment, do it. But that's like saying buy a good house for less than market price. It's tough to do. If you want to retire, you'd probably do well to get your money out of your savings account and into the market. If you can find cheap stocks, great, but don't wait because that may never happen. Buffet may represent the last generation able to systemically find under-priced stocks. You and me? We may have to pay retail.

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