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Buffett Recommending S&P Index Fund A Mistake, Says Berkshire Shareholder

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Buffett Recommending S&P Index Fund A Mistake, Says Berkshire Shareholder

In an article earlier this week, we posed a simple question: has Warren Buffett lost his touch?

Mark Hulbert, of the Hulbert Financial Digest, says skeptics are being “unfair” on Buffet. Hulbert adds that anyone suggesting he’s lost his touch should cool their heels. He says Buffett hasn’t lost money in the last 10 years. He also mentions that nobody beats the market all the time.

Others, like Howard Gold, a columnist at Marketwatch, points out that Buffett has been “profoundly underperforming” against the S&P 500 and most of his recent deals have been duds.

Buffet Gives Advice

But what irks one investor, in particular, was Buffett’s advice that the average investor should just buy an S&P index fund.

Buffett’s comment came during the Berkshire Hathaway conference call, when he stated “In my view, for most people, the best thing to do is to own the S&P 500 index fund.”

That may be practical advice for the vast majority of Americans. However, Tony Scherrer, a CFA at Smead Capital Management, says that Buffett’s comment completely goes against his own advice.

Scherrer believes that by recommending an S&P index fund, Buffett is telling investors to buy the exact type of companies that he himself has spent his career avoiding.

Specifically, a quote from the 2007 Berkshire Hathaway shareholder letter, where Buffett says:

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”

Scherrer takes each part of the statement and points out where Buffett contradicts or simply ignores his own advice. He starts with:

“The worst sort of business is one that grows rapidly…”

The S&P 500 has 21% of its weighting in just five stocks: Microsoft, Apple, Amazon, Facebook and Alphabet. Scherrer points to research by David Kostin at Goldman Sachs that shows these top five names have an expectation of revenue growth of 14% over the next two years, and trade at 28x the forward two-year earnings average. The other 495 stocks in the index are expected to grow revenue much slower, at 4% over the next two years, but also trade at a much lower 14x the forward two-year earnings average. In other words, buying the S&P index fund means paying twice as much (28x vs. 14x) for a handful of stocks that are growing rapidly.

“…requires significant capital to engender the growth…”

Netflix, Amazon and Facebook are among the heavily weighted stocks in the index, and Scherrer says they are all burning through significant amounts of money to keep growing.

“Netflix’s cost for its content has mushroomed from $4.5bn five years ago to an expected $15bn in 2020 and will have to continue to expand to operate its business. Amazon… recently announced a $4bn increase in costs associated with safety of its workers and protection in its warehouses on the heels of its deficiencies… Facebook’s recent quarter included a 34% increase in expenses year-over-year to a whopping $46.7bn, as its cost to acquire new customers and increased regulatory expenses spiked.”

“…then earns little or no money”

Looking at the numbers, Scherrer says ”Netflix burned $3.1bn in free cash flow last year and must persistently ramp that up to attract and retain subscribers. Amazon’s flywheel generated an eye watering $280bn revenue number in 2019, but operating profits for everything outside its cloud business came in at a measly $5.3bn. You currently pay 68x forward price-to-earnings for Netflix, 126x for Amazon, and 28x for Facebook.”

Buffett of the Past v.s. Buffett of the Present

Scherrer believes that if 2007 Warren Buffett met today’s Warren Buffett, there’s no way he would allow him to buy an S&P index fund that is highly concentrated into a handful of stocks that are high growth, capital incinerators that earn very little money.

But 2007 Warren Buffett would probably be most appalled that 2020 Warren Buffett would be selling airlines stocks. That means at some point, Warren Buffett thought investing in airline stocks was a good idea.

In the same 2007 shareholder letter, Buffett outlined what “The Great, the Good and the Gruesome” businesses look like. Buffett described a “gruesome” business by using airlines as an example.

Incredibly, he described them as “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”

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As Airlines Suffer, American Most Likely To File Bankruptcy

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As Airlines Suffer, American Most Likely To File Bankruptcy

A few weeks ago, Boeing CEO Dave Calhoun startled the airline sector when he said a major airline would go bankrupt by Halloween.

“I don’t want to get too predictive on that subject. But yes, most likely,” Calhoun said. “Something will happen when September comes around.”

Airline stocks plunged as investors and analysts scrambled to determine which airline became most vulnerable.

RapidRatings, a risk assessment firm, recently completed a comprehensive stress test on the major U.S. airlines. They used dozens of variables including debt loads, cash flow analysis, and a loss of at least 15% of revenue.

American Airlines To Suffer The Most?

We may never know which airline that Calhoun was alluding to. Although, RapidRatings’ analysis says that American Airlines is the most likely to go bankrupt in the coming months.

The company also looked at Delta, United and Southwest, but none of them are in such dire circumstances as American.

In an interview with Yahoo Finance, RapidRatings CEO James Gellert said, “American is the most at risk and that’s it in every way you look at it. American stands out as the weakest of this cohort.”

The stress tests run by RapidRatings produce both a short term financial health rating (FHR) and long term core health score (CHS). According to RapidRatings, the FHR measures a company’s short-term resiliency and default risk. Meanwhile the CHS analyzes risk and company efficiency over a three year period. A score lower than 40 means a company is at risk of failing.

Gellert says the analysis has more than a decade of proven results. Also, “over 90% of companies that failed have been rated 40 and below on our scales.”

The stress tests found that American was the weakest U.S. airline going into the recent pandemic. It has a financial health rating of 59 and core health score of 66.

As the pandemic unfolded and air travel plunged 90%, American’s FHR score plunged to 29. Meanwhile, its CHS score fell to 27.
Gellert added that “I would be quite certain that is the airline in the crosshairs of the Boeing comment.”

The Future Of American

American, in response to the sub-40 stress test scores, said in a statement that it was “focused on rightsizing the airline for the current environment, and plan to reduce our 2020 operating and capital expenditures by more than $12 billion.”

Analysts, however, are starting to smell blood in the water. Cowen equity research analyst Helane Becker recently told Yahoo Finance, “American’s liquidity position is dependent on government aid, bucking the trends we’ve seen from other airlines. The company is receiving a total of $10.6 billion … [and] we expect another capital raise” in the 3rd quarter.”

Savanthi Syth, an equity analyst at Raymond James, also agrees American will need more capital to weather the storm. “I mean, if you look at the cash on hand that’s definitely the case,” Syth said. American has six months of cash on hand, United has 10 months, Delta has 12, and Southwest has almost 19 months, according to Raymond James.

Syth added, “I don’t think bankruptcy is a foregone conclusion… it’s just going to take longer for American to kind of dig themselves out of this kind of debt burden, and therefore equity could be challenged in the near term.”

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Sorry AOC, Billionaires Haven’t Made $434B During Pandemic

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Sorry AOC, Billionaires Haven’t Made $434B During Pandemic

Nation’s Billionaire’s See Net Worth Jump $434B in First Two Months of Pandemic

It was an eye-opening headline, and fairly drew the frustrations of a lot of us. This is especially true for the 38+ million Americans who have lost their jobs since the coronavirus pandemic shut down. Our country has been at it a little more than two months ago.

How dare they get richer while we suffer?

Chuck Collins, director of the Institute for Policy Studies Program on Inequality, the co-author of the report, expressed his piece. He said, “The surge in billionaire wealth during a global pandemic underscores the grotesque nature of unequal sacrifice.”

Meanwhile, Frank Clemente, the executive director of Americans for Tax Fairness which co-authored the study, also shared his opinion. He said, “The pandemic has revealed the deadly consequences of America’s yawning wealth gap, and billionaires are the glaring symbol of that economic inequality.”

Democrat Alexandria Ocasio-Cortez didn’t want to miss the opportunity to inject her brand of socialism into the public discourse. “Really great system we got here. Can’t imagine why anyone would question how beneficial or sustainable it is for the working class,” she tweeted. This is in response to CNBC running the headline.

The Study’s Flaws

The top five US billionaires explicitly mentioned in the article are all Democrats. These include Warren Buffett, Bill Gates, Jeff Bezos, Mark Zuckerberg, and Larry Ellison. But setting that irony aside, the problem is that the article is simply dishonest, points out MarketWatch columnist Steve Goldstein.

“The study… examines billionaires’ wealth between March 18 — the rough start date of the pandemic shutdown, when most federal and state economic restrictions were in place — and May 19. It relied on the Forbes’ billionaire list, which itself is built around stock-market performance.”

The flaw, as Goldstein points out, is that the beginning and end dates used for the study are incorrect.

“Think about that in the market context. The pandemic did not start March 18 (nor, of course, had it ended on May 19), and certainly market concerns about the pandemic did not start March 18. Far from it.”

He says that to see a true picture of how much money the billionaires made – or lost – during the pandemic, they need to expand the date range.

“A more logical way to think about whether billionaires got richer, or not, is to think about the performance from the Feb. 19 peak in the market, after which more investors began to get concerned by the novel virus. You then get to see who got richer even in the face of the crippling economic blow.”

If you use this revised date range, Goldstein says the truth is that billionaires have actually lost money since the market peaked and the pandemic began

“Cumulatively, the top 50 billionaires lost $232 billion between the market’s peak and this Tuesday. If the remaining billionaires on the Forbes list lost wealth at the same roughly 12.5% rate that the top 50 experienced, that’s another $200 billion–plus wiped out.”

So while it’s easy to run a headline that bashes billionaires, the truth lies somewhere in the middle.

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Many Americans Put Their Stimulus Checks Into The Stock Market

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Many Americans Put Their Stimulus Checks Into The Stock Market

The government sent $1200 stimulus checks to help Americans pay their bills. However, it turns out that many people turned around and put most of that money into the stock market. This is according to research done by Envestnet Yodlee, a data aggregation company.

Bill Parsons, Group President, Data Analytics at Envestnet Yodlee said during a recent CNBC interview, “Covid is causing conversations among family members and family members with their advisors about what to do with their money and were seeing that in the data… Securities trading did see significant lift week-over-week and I suspect that that’s in part due to big changes in the market.”

People Investing in Stocks

In most income brackets, data shows that buying stocks was the second or third most common use for the funds. Fortunately, the most common uses of the stimulus money were increasing savings and cash withdrawals.

The company started tracking the spending habits of 2.5 million Americans in early March. It noticed a divergence in behavior in mid-April when the checks started to arrive in mailboxes. Those that received their check increased their spending by 81% compared to the prior week. Some of that spending went into the stock market.

In the $35,000 – $75,000 income bracket, stock trading increased by 90% in the week the check was received compared to the prior week.

In the $100,000 – $150,000 income bracket, trading increased 82% in the week the stimulus check arrived. Meanwhile, in the $150,000 or higher income bracket, stock trading only increased by 50%. The $150,000 or higher bracket would not have been eligible for a stimulus check. Therefore, it acts as a good baseline.

New Online Trading Accounts

All of this stock buying meant a whole lot of new online trading accounts were opened in the last month or so. However, the brokerage houses aren’t sure if that is due to the stimulus checks, or the opportunity to buy stocks cheaply as the market fell.

Charles Schwab reported “monumental volumes” as it opened 609,000 new accounts in the first quarter. Additionally, the stock trading app Robinhood reported daily trade volume was up 300% in March compared to the previous year. The company co-CEO also said during an interview with CNBC that over 50% of its customers are first-time investors.

You may believe the brand new investors were wise enough to buy stocks because they recognized they were cheap and the markets would rebound. Either way, it seems they have very good timing.

Since the market bottomed in late-March, stocks have staged a tremendous rally in the last two months, with the Dow Jones Industrial Average and S&P 500 climbing nearly 35% from their March lows, and the Nasdaq gaining more than 40% over the same time period.

It’s better than spending the money on weed, sneakers and video games.

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