Annual letter to limited partners – 1959
In the year 1959, the Dow-Jones industrial average (DJIA) was up 16.4%. With dividends factored in, the total return from the market in that year was about 20%. In spite of this, more stocks listed in the US declined (710) than went up (628).
Surprised? Don’t be! This happened in India as recently as last year. This is because both the constituents of SENSEX(30) and NIFTY(50) form a very small part of the overall universe of listed companies in India (5000+). Both these indices primarily have large-cap businesses as their constituents. So, in a year like last year when large-cap blue-chip stocks rallied ahead, the indices record gains. But those gains offer no view about the actual gains recorded in mid-cap and small-cap stocks. As an equity investor, it is important for you to compare the performance of your portfolio or your mutual fund with the right benchmark. And this is why we have NIFTY500, small-cap index, mid-cap index etc.
When stock market gains are limited to a few large-cap businesses, most mutual funds will struggle to beat the performance of the index. And that is exactly what happened in the US in 1959. Some of the largest fund houses at that time like Tri-Continental Corp., and Massachusetts Investors Trust struggled to beat the gains recorded by DJIA index. And every major fund manager of that time, including Buffett, said that the markets are substantially overvalued. Value investing as an investment philosophy came to be questioned!
This is happening now as well! Value investing has lagged some of the other investment styles like growth and momentum-based investing. But it may change.
Buffett says, “Perhaps other standards of valuation are evolving which will permanently replace the old standard. I don’t think so. I may very well be wrong; however, I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a “New Era” philosophy where trees really do grow to the sky.”
In 1958’s letter (which you can read here), Buffett wrote about an opportunity which involved about 25% of assets of the various partnerships. In 1959, that opportunity was about 35% of the asset base of the portfolios. For anybody in the financial markets, that is a very concentrated position.
Buffett throws some light on this investment in the 1959 letter. He says that this is an investment in a trust which holds 30-40 other stocks/securities in its balance sheet. The Buffett partnerships made an investment in the company at a substantial discount to the market value of the securities. Also, Buffett was now the largest shareholders of this company. Why was it so undervalued in the first place and how is Buffett going to unlock value from this business? He talks about in the letters to come. But in 1959, he only says that the probability of superior performance from this investment is extremely high and that the value unlocking event will take place in the next year.
The rest of Buffett’s portfolio (65%) in 1959 was invested in general undervalued stocks and workouts. And for the third year in a row, Buffett says that his investment style should lead to superior results in bear markets and average results in bull markets (Why? Read here)
To be continued...