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Cheerleading the S&P 500 Index

As clients and readers know, we've long followed the general investing principles of Ben Graham and his mentee Warren Buffett (noted on our web site under Business Model > Philosophy), which can more or less be summarized as buying good businesses at great prices and great businesses at good prices. Graham was better known for the former (sometimes even finding opportunities amongst poor businesses, aka "cigar butts") and such opportunities were more readily available during his investing career. Buffett started with the former but has become better known for the latter, with a big hat tip to right hand man Charlie Munger.

The key investing lesson offered by Graham and Buffett - as we see it - is that price and value are not the same thing. You cannot make a well-informed decision about any investment until you know the price and separately study/research/understand the value. The bond of a bankrupt company can be a wonderful investment at the right price. The stock of the bluest of blue chips can be a very poor investment at the wrong price. It all depends on price.

So, we read Buffett's letter to Berkshire Hathaway shareholders each year and generally pay attention to what Berkshire is and isn't doing. But with all due humility (and that is a LOT of humility), we don't blindly follow anyone. No one is infallible. I've disagreed with Buffett decisions over the years (e.g. initial handling of David Sokol and Lubrizol; Coca-Cola executive compensation). I just try to learn and understand and then make up my own mind about whether something makes sense. And I do that knowing that I'm as capable as anyone of being wrong and looking foolish (as has been the case in recent years).

Bill Smead of Smead Capital Management offered an interesting take on Buffett's comments at the recent Berkshire Hathaway meeting on May 2nd. Smead is a value-oriented investing shop, with similar principles to Buffett and Berkshire. Writing on May 4th, Smead disagreed with many of Buffett's comments(1) - see link below. The section of Smead's letter that strikes a particular chord with me is the section titled "Cheerleading the S&P 500." He presents a broad outline of index performance since the peak at the end of the roaring 20s:

1929 - 1954: index terrible

1954 - 1964: index terrific

1964 - 1982: index terrible

1982 - 1999: index terrific

2000 - 2011: index terrible

2012 - 2019: index terrific

2020: Forward unknown

As Smead says: "The index is just a portfolio of stocks that gets popular and must be sold every ten to fifteen years or gets deeply out of favor and deserves an investment. Where are we in that continuum?" Well, Smead doesn't know for sure and neither do we. Will the pandemic spell the end of an exceptional run for the index? Right now, the answer appears to be no. U.S. large cap growth stocks have dominated all other asset classes around the world for many years now, led by the ubiquitous FANMAG (Facebook/Apple/Netflix/Microsoft/Amazon/Google). FANMAG seems to be sailing through the pandemic with ease, increasing share of index and markets. Fine businesses, no doubt, that should continue to perform nicely. But the issue is price. The issue is paying a lot for the presumed future performance. The trend of the last seven years cannot go on forever - one way or another it will cease (topic for another day). We just don't know exactly when.

In the meantime, we are content to find investments outside the major indexes. Less growth, perhaps, but better price. It all depends on price.



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