Interesting article about price to earnings....and Warren Buffett....Democrat and one of the richest people in the world...
What Would Warren Do Now?
Timothy Vick, author of How to Invest Like Warren Buffett, finds some stocks that would meet the legendary investor's criteria
NOVEMBER 19, 2002
INVESTING Q&A
yahoo.businessweek.com:/print/bwdaily/dnflash/nov2002/nf20021119_4853.htm?pi
What Would Warren Do Now?
Timothy Vick, author of How to Invest Like Warren Buffett, finds some stocks that would meet the legendary investor's criteria
Buying out-of-favor companies and taking them private under the umbrella of Berkshire Hathaway is the likely strategy Warren Buffett would follow today. That's the opinion of Timothy Vick, senior analyst for Arbor Capital Management and author of How to Invest Like Warren Buffett.
The closest parallel to the current market is that of 1990-'92, when Buffett did just that, Vick says, but he adds that far fewer companies are bargains today. However, Vick predicts that, three years from now, the best-performing stocks will be those that look like losers today.
Among the stocks Vick likes now -- and that he says would meet the Buffett criteria -- are Washington Mutual, Merck, advertising giant Omnicon, and H&R Block. Vick is also attracted to some REITs, though he advises caution in some areas of real estate. REIT names he does like include AvalonBay Communities, Health Care Property Investors, Duke Realty, and Equity Office Properties.
Vick made these points and many others in an investing chat presented Nov. 14 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A full transcript is available on AOL at keyword: BW Talk.
Q: Timothy, the market rally came back to life today. Do you think it has real staying power?
A: That will depend on how well investors want to react to the conflicting economic information they're likely to get over the next several months. My instincts tell me that we have seen about 95% of the bad news that we are going to see. That's a refreshing sign, to be sure. Two years ago, I thought the chances of a rallying market were pretty low. Today, I take the opposite tack.... Going forward, much will depend on how well the economic recovery, and corporate earnings, can sustain themselves.
Q: From your study of Warren Buffett's strategy, how would he be investing right now (if he would be)?
A: The closest parallel we have to how Mr. Buffett may behave is the 1990-'92 period, in which he took a number of positions in cyclicals that were on the rebound and took companies private during a downturn in their industry in order to enjoy the benefits of their growth during the ensuing expansion period.
What is different today is that Mr. Buffett will not find nearly as many values in common stocks as he could 10 years ago, when many, many blue chips were trading at eight times earnings or below. Today, he's facing a situation where blue-chip companies have fallen from 35 times earnings to 20 times earnings. They're not screaming "bargain" in his mind.
Instead, I suspect Mr. Buffett will continue to buy out-of-favor companies and take them private under Berkshire's umbrella. He seems to have a knack for finding companies willing to sell to him at 10 times earnings or below and milk those companies for their cash flows. He's building for himself an empire of cash-generating companies that will give him the opportunity to really juice [Berkshire Hathaway's] operating and investment earnings in the future. He handled this bear market brilliantly, although we will not see the full effect of his genius until the economy is well into the next expansionary phase.
Q: Is it a good time to invest in BRK.B (Berkshire Hathaway) shares?
A: I wouldn't call Berkshire a value play, not in the least. However, I'm always in favor of owning pieces of companies that are well-run, and whose top executives are steeped in integrity and honesty and are driven to create value for shareholders. I think Mr. Buffett would agree that his own stock is not particularly cheap. However, for someone seeking diversification, especially within the insurance industry, you should have Berkshire Hathaway in your portfolio. I would tend to build positions by averaging down with this stock.
Q: Do you see specific companies out there, Tim, that would meet Buffett criteria and might be plays for the average investor now?
A: The recent declines in the market gave investors their first opportunities to pick up blue-chip companies at decent prices. For example, we thought that companies like Intel (INTC ) were attractively priced at $14 or so. Washington Mutual (WM ), a well-run thrift, was a steal at $28. Drug stocks such as Merck (MRK ) recently traded at multiples to earnings that have not existed in about eight years. The decline in General Electric (GE ) stock to about 15 times earnings is also very intriguing.
One stock we added to our portfolios recently was the advertising company Omnicom (OMC ), which we thought was a steal when it fell to around $40. Interestingly, we read today that Berkshire Hathaway began accumulating 500,000 shares of Omnicom within the past several weeks. I think that's an outstanding company that finally fell to an attractive price. That's the great thing about a bear market. You finally get a chance to pick up your favorite companies as they fall in your lap one at a time.
Q: You mentioned Merck. How do you rate drug companies like Pfizer (PFE )?
A: I like Pfizer a little more than Merck, to tell you the truth. But so does everybody else, which is why Pfizer bears a higher p-e ratio than Merck. I'm very confident about the long-term prospects for the drug industry and still believe that a good share of an investor's money should be in pharmaceuticals going forward. Pfizer would be very attractive to me at a price around $25, which would put the value of the company at around $150 billion.... It's one of those stocks that we bought with the intention of holding 10 years or more.
Q: What's your opinion of small-cap stocks now?
A: To be truthful, I don't automatically segment my stock buying by size of company. I'm a generalist by trade, and I think you should be, too. I'm not in favor of allocating certain portions of your portfolio to small cap just for diversification purposes. If you find a compelling company selling for a very low price, but which offers very good rate-of-return potential, buy it. I think too many people get trapped into thinking about sectors and market capitalization, which is an excuse not to focus on individual company performance.
Q: What do you think of REITs? Is the group still a good way to invest for income?
A: I took a very large position in REITs about 24 months ago, as a way to hedge clients' portfolios against overvalued large caps. It ended up being a very good bet. Not only were we able to find a number of REITs with yields above 10%, but we found many that gave us 30% to 40% increases in price as well.
However, we just finished a very exhaustive internal study of the REIT industry, and are far less enthusiastic these days. Some sectors of real estate clearly are starting to roll over -- such as apartments, retail, and office and industrial. Be very careful when looking at these sectors. It doesn't take a very large drop in occupancy rates for earnings to plummet if you have saddled yourself with too much debt. If earnings fall, the dividend is likely to fall as well.
We know from experience that most investors buy REITs for the high yield, not for the price appreciation. When these companies are forced to cut their dividends -- and many will [over] the next couple of years -- the share prices must fall to reflect that. Some REITs that look attractive to us include AvalonBay Communities (AVB ), Health Care Property Investors (HCP ), Duke Realty (DRE ), and Equity Office Properties (EOP ).
Q: Is it a good time to buy property? Or is that the next bubble? Actual property, not REITs.
A: I have talked with a number of investors the past six months who have decided to throw in the towel with equities and start buying real estate. It's a bit frightening to see that trend develop, for it may portend another bubble in real estate. A lot of investors simply gave up when the market bottomed in July and got out of equities -- in my opinion, at the wrong time -- only to chase another sexy sector.
The great thing about real estate is that it's extremely diverse. It's impossible to have bubble conditions prevalent everywhere in the United States.... Everything comes down to rate-of-return potential. If you invest prudently, you can get very high cash-on-cash returns in real estate. However, given the decline in the stock market the last couple of years, I still believe that the best returns going forward will be in equities. I would not have said that two years ago.
Q: Do you like any financial stocks? Any word if Warren bought stock in Citigroup (C )?
A: I have not heard of Mr. Buffett's interest in Citigroup. I liked that stock back in July when it bottomed at around $24. At that price, which was about $120 billion in market cap, the stock fully reflected all the bad investments and ethical problems the company could face. If Citigroup declined back under $30, I would be interested again.
We also took positions in Alliance Capital (AC ), a mutual-fund partnership. Since it is a partnership, the company kicks back almost all its earnings to you every year as a dividend.... We also like H&R Block (HRB ), which recently fell below $30 on worries over its mortgage division, and because of an investigation into some of its lending practices. Block is a great franchise, and we've been looking at the company and waiting for a decent price for more than two years. It possesses a great franchise.
Q: What's your take on tech stocks?
A: I don't look at tech stocks just because I want, or need, to be in the sector. Like any company, I look first for a sustainable franchise with a competitive advantage that can generate high returns on equity and invested capital. I shy away from many tech sectors for the same reason that Warren Buffett does. Nobody can really predict what will happen to half these companies five years out.
Q: Can you list other stocks that meet your criteria now?
A: If you're willing to take chances on turnarounds, I might suggest looking at stocks such as Tyco International (TYC ), Ford Motor (F ), Great Lakes Chemical (GLK ), McDonald's (MCD ), CSG Systems (CSGS ), or Reuters (RTRSY ).
Q: Buffett has favored consumer stocks over the years. Do you have any favorites in this area now?
A: It has been a while since Buffett has bought into the consumer sector. He made great money on companies such as Gillette (G ) and Coca-Cola (KO ), but keep in mind he made those purchases more than a decade ago, when those stocks were supercheap.
There aren't too many stocks in that sector that are blowing me away right now, but being the contrarian bottom-fisher that I am, I can't help but notice that the grocery-store sector is lying about as flat as a pancake right now. Sooner or later, companies such as Safeway (SFY ), Kroger (KR ), and Albertson's (ABS ) will rebound and generate a very strong long-term return from current prices.
I think the advertising company Interpublic Group (IPG ) has tremendous turnaround potential, once the company straightens out its internal accounts. That's the key dilemma you all will face in the current market. The stocks that you really want to buy are turning cheap, only because they're experiencing very severe, hopefully temporary problems.
You've got to be able to step to the plate, take a long-term perspective, and see the forest through the trees. Nobody likes buying into a negative trend, nor do they want to touch any company currently experiencing problems. But I'm very confident that when we have this conversation again in 2005, I will be willing to say that the best-performing stocks over the past three years were the stocks that everybody gave up for losers in 2002.
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Edited by Jack Dierdorff
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