Buffeted By The Market Billionaire Investor’s Batting Average Slips With Recent String Of Bad Bets
Warren Buffett, America’s folksy billionaire investor from Omaha, confessed recently that his investment in USAir Group was a result of “sloppy analysis” that might have been caused by “hubris.”
Now, hubris is something Buffett, 64, might be allowed, given his record since he started buying six-packs of Coke for 25 cents and reselling the bottles at a nickel apiece as a child in the late 1930s.
He is worth more than $11 billion and the stake his company bought in CocaCola just a few years ago has more than quadrupled to about $5.9 billion. “It took only 50 years before I finally got it: The real money was in the syrup,” Buffett quipped recently.
But sloppy analysis? Few people have ever accused him of that. Yet Buffett’s mea culpa, along with some less-than-stellar forays into the stock market in recent years, suggest the unthinkable: The legendary Buffett is in a bit of a slump.
A look at some of his biggest investment disappointments - including USAir, Salomon Brothers, PNC Bank Corp. and Champion International - shows that Buffett has at times strayed from his own axioms for success.
Among those axioms: Don’t try to time the market; invest in businesses with histories of steady earnings growth; invest for the long term; don’t invest in something that you don’t fully understand; invest in managements with proven track records, and don’t get involved in the management.
Buffett also seems to have fallen victim to a problem familiar to many ordinary investors: letting the desire for better-than-average returns blind one to the weaknesses of the companies in which one invests.
It’s not as though Buffett is about to be knocked from his pedestal. Berkshire Hathaway Inc., the holding company that is his investment vehicle and of which he owns 41 percent, still produces returns that are the envy of Wall Street, outperforming the Standard & Poor’s Index of 500 companies by double digits year after year.
It’s just that his performance has slipped noticeably since he began stepping in as a savior of companies threatened by hostile takeovers in the late 1980s.
From 1965 through 1986, Berkshire Hathaway’s net worth increased at an average compound annual rate of 23.63 percent, beating the S&P 500 by 14.38 percentage points.
From 1987 through 1994, its average return slipped to 21.87 percent, narrowing its edge over the broader market to 10.02 percentage points.
The decline was a bit like that of the baseball star Wade Boggs: After hitting an untouchable .345 over a decade, Boggs’ average fell to a merely mortal .259 in 1992 and a merely sterling .302 in 1993.
Boggs’ fans wondered what had gone wrong. And now, some investors are asking what, if anything, has gone wrong at Berkshire Hathaway.
One answer is that, under pressure to maintain his fabulous returns, Buffett began to ignore some of his own advice.
At the end of the 1980s, he started putting money into high-yield investments in companies threatened with hostile takeovers - companies he has admitted he didn’t always fully comprehend.
The change in strategy was exemplified by Buffett’s forays into USAir, Salomon, and the paper and wood products giant Champion International.
These investments were made by buying convertible preferred stock, which pays a high interest rate and can be converted into common stock. Buffett is reputed to have once called these instruments “Treasury bonds with lottery tickets attached.” Their effective yield for Berkshire Hathaway was around 15 percent.
One mistake led to another. Stuck with some troubled companies, Buffett decided to get involved in managing some of them and he has not proved adept at that. He had to step in to act as chairman of Salomon after it was rocked by a 1991 scandal involving false bids at Treasury auctions. Four years later, he is still struggling with the firm.
Salomon, USAir and Champion also violated another Buffett rule: They had erratic earnings histories.
And had Buffett hewed more firmly to his principle of buying and holding, he could have made a lot more money from the one-third stake in Capital Cities/ABC Inc. that Berkshire Hathaway sold in late 1993.
Holding on to the stake for 12 more months would have brought in an additional $217.5 million at today’s price.
Such missteps are taking a toll. Berkshire Hathaway’s earnings dropped last year, to $494.8 million from $688.1 million in 1993, because of a $173 million write-down of the investment in USAir and a $33 million hit on the Salomon equity holdings.
The stock of Berkshire Hathaway, now at $23,050 a share, has risen roughly in line with the overall market this year, but is 7.5 percent below its all-time high.
Buffett declined to be interviewed for this article. But he has told stockholders on more than one occasion that investing is a lot more difficult these days than it was in Berkshire’s earlier years, when a lot of “low fruit” hung ripe for the picking in the stock market.
Peter Russ, an analyst at Shelby Cullom Davis and a staunch admirer of Buffett, said that to some extent Buffett was a victim of his own success.
Because he has so much money to invest, and because stocks are trading at such high price-earnings ratios, it has become more and more difficult for him “to find mispriced companies in wonderful situations,” Russ said.
“The past seven years have been very difficult for the Warren Buffett style of investing,” Russ said.
Looked at as bond investments, Buffett’s holdings of convertible preferred stock in USAir and Salomon don’t seem so bad because of their high yields.
But as equity investments, they seem less smart. Because of the serious financial problems at USAir, Buffett has written down his original $358 million investment to $89.5 million. “He paid a lot of money and his conversion price was high,” says Steve Gidumal, an airline analyst at Bear Stearns.
In Berkshire Hathaway’s 1994 annual report, Buffett recognizes his mistake. “This was a case of sloppy analysis, a lapse that may have been caused by the fact that we were buying a senior security or by hubris,” Buffett wrote. “Whatever the reason, the mistake was large.”
Buffett has also had to write down his Salomon convertible preferred investment by $33 million to account for his share of the investment bank’s 1994 net loss of almost $400 million.
Salomon’s troubled client businesses lost $179 million in the first three months of 1995, though firstquarter trading profits of $239 million pushed the company out of the red for the first time in a year.
Investments in pulp and paper companies, especially those like Champion International that own a lot of trees, have historically been a good hedge against inflation. But while Champion’s senior securities, another convertible preferred investment, have provided a good return, the company lost money from 1991 through 1993, though its share price has risen recently.
But it is at Salomon, a unit of Salomon Inc,. where in 1987 he stepped in to buy $700 million of Salomon convertible preferred securities to rescue the firm from the investor Ronald Perelman, that Buffett faces some of his greatest challenges.
Altogether, Buffett has invested more than $1 billion in Salomon, and Berkshire Hathaway holds just over 20 percent of the firm’s total voting rights.
In recent weeks, more than 20 managing directors have deserted the investment firm, many of them because they were unhappy with his plan to limit their annual compensation to $400,000 unless certain profit targets are met.
The exodus forced Buffett’s managers to modify the plan somewhat to keep top talent.
But great players, whether in Major League Baseball or on Wall Street, have a way of breaking their slumps. And for Buffett, the recent rally in Salomon stock, which has jumped from $32.25 in March to $39.375 Thursday, may be a signal that in the long term, the old Buffett magic is still there.