I’ve already blogged about Buffet’s annual letters twice: in 2018 I wrote about a few quotes, and in 2019 I wrote about some lessons learned.
Now I have to confess that after some six or seven years of reading them they are getting a bit repetitive, although there is always something new. This year the new thing is some interesting idea Buffett shares from a quasi-obscure book from 1924 I had never heard about before: “Common stocks as Long Term Investments” by Edgar Lawrence Smith.
The background
Writing about “The power of retained earnings” Buffett tells us in the letter that Smith, the book’s author, assumed that the performance of stocks would beat that of bonds when there is inflation. And, conversely, that bonds would beat stocks when there is deflation. But of course, he, Smith, found that stocks always win.
Buffett also quotes John Maynard Keynes reviewing the same book claiming that well-run industrial companies retain the bulk of their earnings and reinvest it in the business. Keynes endorses the book and, indirectly, endorses Buffet who at Berkshire Hathaway does not pay a dividend and rather reinvests via buybacks returning value to stockholders.
The book
Book review
Are you curious about the power of common stocks as long-term investments? Look no further than Edgard Lawrence Smith’s book, “Common Stocks as Long Term Investments.” Written in 1924, this book remains a timeless classic in the world of finance. In this review, we’ll explore its findings and relevance in today’s market.
Smith’s book is a quick read, with only 112 pages. But don’t let its size fool you – this book packs a punch with valuable insights and surprising findings.
These studies are the record of a failure -the failure of facts to sustain a preconceived theory.
Edgard Lawrence Smith
One of the least shocking findings is that common stocks outperform bonds over the long term. This may not seem surprising today, but in 1924, bonds were considered a safer investment. However, Smith’s research showed that from 1900 to 1922, common stocks returned an average of 8.5%, while bonds only returned an average of 4.1%. This finding still holds true today, as common stocks continue to outperform bonds over long periods.
One surprising finding is that dividend-paying stocks outperform non-dividend-paying stocks. Smith’s research found that dividend-paying stocks returned an average of 10.2% annually, while non-dividend-paying stocks returned only 5.0% annually. This may seem counterintuitive, as non-dividend-paying stocks are often thought to have more growth potential. However, Smith’s findings suggest that companies that pay dividends tend to be more stable and profitable in the long term.
A third finding from Smith’s book is the importance of reinvesting dividends. Smith found that reinvesting dividends can significantly increase long-term returns. For example, if an investor had invested $1 in the stock market in 1900 and reinvested all dividends, their investment would have grown to $198 by 1922. However, if they had not reinvested dividends, their investment would have only grown to $69. This finding highlights the power of compounding and the importance of reinvesting dividends.
So, what is the relevance of Smith’s findings to today’s market? Despite being written almost a century ago, Smith’s book is still relevant today. The power of common stocks as long-term investments, the importance of dividends, and the value of reinvesting dividends remain true. Additionally, Smith’s book highlights the importance of patience and discipline when investing, two qualities that are just as relevant today as they were in 1924.
Buffett’s take
As stated before, Berkshire doesn’t pay dividends and rather retains earnings to reinvest into the business. This is also true for all “controlled” companies (where Berkshire owns at least 50%). For other companies not controlled he only reports the dividends as Berkshire’s earnings. He doesn’t forget, however, that the companies also have retained earnings that are kept within those businesses and “work hard creating much added value”.
References
The book https://amzn.to/2WiVcKw
This year’s letter https://www.berkshirehathaway.com/letters/2019ltr.pdf
So, are bonds worth it?
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