U.S. Market Cools; Thoughts on Berkshire Hathaway And Investing

In April of 2012, U.S. financial markets cooled off as the Dow Jones Industrial Average rose by .01%, the S&P 500 retreated .51%, and the Nasdaq went down 1.5%.  It is only natural that the equity markets have cooled off from the hot start during the first quarter. 

Naturally, many investors are concerned about what the next problem will be.  Is it the continuing sovereign debt crisis in Europe, a slowing down of the Chinese real estate and economy, or high oil prices?  Maybe a large increase in the rate of inflation, or a general demise in the growth rate of the U.S. economy is the next shoe to drop?  Why stop at potential economic concerns which will bring the stock market down?  Instead, we could look at every possible world problem in an effort to find reasons why stock markets should not rise?

Let’s see, we could mention the high concentration of wealth in a few holders' hands, the lack of affordable health care for many people and rising health insurance rates every year, or I am sure you can think of something else which comes to mind.  Stock markets have underperformed bond markets over the last fifteen years, but with the surge of profitability in the corporate world stocks should continue to do well.  It is hard to focus on what matters when the world is full of troubling issues. 

However, as an investor, there will always be situations which could negatively impact business.  In many instances, there is a short term effect because of a one-time event, like last year we had the earthquake in Japan or Arab spring.  If one extends the time frame past 6 months or a year, profitability becomes the main determinant as to how stocks will perform.  

There is still quite a bit of fear in U.S. financial markets, and one only needs to look at the very low bond yields on U.S. Treasuries to see it. I expect the spring and summer will sport lower trading volumes and slower business conditions, which is typically the case in the financial year.  The slowdown does not mean stocks won’t go up (or down), just that activity will probably start to become a little lighter now, especially when earnings season winds up. 

One should always expect the unexpected, but we might see a very uneventful upcoming few months in financial markets.
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‘The World Shall Be Your Oyster.’  If you are looking all over the world for investment opportunities, 2012 has been a year when there have been many areas which have performed well, so far anyway.  The BRIC countries have been very solid, posting year to date results of: Brazil (+8.7%), Russia (+15.4%), India (+10.9%), and China (+11.9).  Other countries in Asia have even better results, as seen by Hong Kong (+12.5%), the Phillippines (+18.2%), Thailand (+18.2%), and Japan (+12.6%).  

Some countries in Eastern Europe also have posted strong returns for investors.  For example, Austria is ahead by 11.9%, Germany is up by 15.3%, Denmark has gained 16.7%, and Turkey and the UK (FTSE 25) have returned 18.2% and 13.6%, respectively.

The areas of the world which are lagging behind include Spain (-16.6%), Italy (-2.1%), Portugal (-5.9%), and Canada +2.4%).  It will be interesting to see if the outperformance in Asia and the BRIC countries continues or if the mature European countries can start to improve their results. 
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When we welcome in the month of May, two annual events which occur each year come to mind- The Kentucky Derby and Berkshire Hathaway’s Annual Meeting.  If ever there was a great contrast to be made, those two festivals embody the vast world of difference in the participants.  In the Kentucky Derby, people wager on horses in an effort to make a return on their capital. 

With the Berkshire Annual Meeting, shareholders have placed their money in a company which owns something like 70 businesses with over $50 billion dollars of sales.  Those businesses have been put together by the greatest investor who ever lived, Warren Buffett.  Over the last few years, Berkshire Hathaway (BRK.A) shareholders have suffered through a once in a lifetime situation: the stock has not gone up.  All is not lost however, it can yet go up.  If one loses in the Kentucky Derby wager, your money is gone, sionara, finito, ari viderci.  A major difference, don’t you think?
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Many people equate investing in the stock market to gambling.  With the implementation of decimal trading, the invention of double and triple leveraged exchange traded funds, algorithm based trading, and high frequency traders, there are many elements in the current market environment which do resemble a casino.  However, one must understand what a buyer gets when they own the equity of a company. 

When you own the stock of a company, you own a claim on the company’s assets after all liabilities are paid, and whatever income those assets generate.  So, let’s say you own the stock of a company which has a net cash position of 100 million dollars (cash-long term debt).  If there are 10 million shares outstanding, this equates to $10 per share of cash on the balance sheet.  If the company has net income in a year of $10 million dollars, the company is generating $1 dollar per share in earnings per share.  (Diluted earnings per share just includes what all the shares would include if one converted stock options, preferred stock, or convertible stock into common stock) 

So, if the stock were selling for $5 dollars per share in the stock market, you would be paying .50 cents on the dollar for the cash on the balance sheet, and getting a company with a P/E ratio of 5.  The P/E ratio is simply the price divided by the earnings per share.   There are different kinds of P/E ratios- trailing and forward.  Trailing uses the past year of earnings where forward uses the projected earnings in the upcoming year.  So, a good question would be, in the above example- do we buy, sell, or hold?
   
Seems pretty simple, but a wise investor would say- “Tell me about the business.  What industry is it in?  What is the competitive position of the company?  What were the last 5 years of earnings like?  How quickly are revenues growing?  Are operating profits growing at the same rate of revenues?  What is the cash flow historically been?  Is the business capital intensive?   How does the company plan on utilizing its cash?  Is it interested in growth, or paying dividends?  Is the company planning for international expansion?  What countries are they currently in?  What does the pipeline for growth look like? “  There are plenty of other questions which should be asked as well. 

The key is gathering tons of information on the company and distilling it all into a decision about whether you think you are getting a lot for your money.   Well, that is how I look at it.  I know this, by buying a stock, you certainly are not betting on the pass line, or hitting on a 16 when the dealer has 21.
   
One of the hardest parts of investing is coming to grips with the reality that every stock you look at has issues.  I looked at quite a few this weekend, and all had some situation which would give a buyer pause. 

Education stocks are in the doghouse because of problems with student loan funding and the federal government.  Natural gas stocks are beaten down because of record low natural gas prices.  Pharmaceutical stocks are cheap because of drug patents are causing the most profitable drugs to become generics.  Bank stocks are impeded by the housing overhang and flat yield curve.  Big tech is too big and too dependant on the PC industry.  Apple (AAPL) is missing Steve Jobs. 

You get my point, but in my mind, the key is to try and be open minded about the strengths of a company, as well as the issues it faces.  After you look at a lot of companies, you begin to understand that you want to understand what exactly are you getting when you buy the stock of company XYZ.  By the way, the answer is yes, it is a screaming buy. 

Disclaimer: It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives.