September 21, 2018

Warren Buffett on P/E ratios and the future looking different from the present

One of the best buys we ever made was in 1976 when we bought a significant percentage — what became through repurchases — 50 percent of GEICO at a time when the company was losing a lot of money and was destined to lose a lot of money in the immediate future.

And, you know, the fact they were losing money was not lost on us, but we thought we saw a future there that was significantly different than the current situation.

So it would not bother us in the least to buy into a business that currently was losing money for some reason that we understood, and where we thought that the future was going to be significantly different.

Similarly, if a business is making some money — there’s no P/E ratio that we have in mind as being a cutoff point at all. There are businesses — I mean, you could have some business making a sliver of money on which you would pay a very, very high P/E ratio.

...There are all kinds of decisions that involve the future looking different, in some important way, than the present. Most of our decisions relate to things where we expect the future not to change much.

But you get this — well, American Express was a good example. And when we bought it in 1964, a fellow named Tino DeAngelis had caused them incredible trouble. You know, it was one of those decisions that looked, for a time, as if it could break the company.

So, we knew — if you’d been charging for what Tino had stolen from the company against the income account that year, or the legal costs that were going to be attached to it, you were looking at a significant loss.

But the question was, what was American Express going to look like 10 or 20 years later? And we felt very good about that.

So there are no arbitrary cutoff points. But there is that focus on, how much cash will this business deliver, you know, between now and Kingdom Come? Now as a practical matter, if you estimate it for 20 years or so, the terminal values get less important.

So — but you do want to have, in your mind, a stream of cash that will be thrown off over, say, a 20-year period, that makes sense discounted at a proper interest rate, compared to what you’re paying today. And that’s what investment’s all about.


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