1/ I want to reflect on several topics: Apple stock (which many own either outright or through many workplace 401k funds), stock market valuations and the future of returns, and Charlie Munger's comments this past week at the Sohn Conference.
2/ Charlie Munger offered a very profound observation when he said that the current market mania is crazier than the 1990s and "everyone who bought a stock at a P/E ratio 10 and now finds it at 35 thinks himself a genius" when criticizing the nature of current investment gains.
3/ That was clearly a veiled reference/synecdoche where he was Berkshire Hathaway's returns with Apple stock over the past five years (bought at an average price of 12x earnings and now trading at 28x earnings) as a shorthand for much of the market as a whole.
4/ First of all, I would engage with Munger's point slightly differently. Someone who bought Apple at 10x earnings does deserve credit for seeing a durable franchise at an incredible price and seizing the opportunity. That single decision could make an investing career.
5/ Seriously, someone with a 30 year time horizon who allocated say $100k into Apple stock could possibly due nothing else for an entire investing career and lead a very good later life on the proceeds of that decision alone. Hence, the appeal of investing.
6/ But I also want to give full effect to Munger's point. A lot of money gets made with a shift in P/E ratio + growth. It is a potent one-two punch. Apple had $120 billion in cash, $60 billion in debt, and a rock-bottom valuation when Berkshire started buying it.
7/ Now, Apple has the high valuation of 28x earnings, $120 billion in debt and $60 billion in cash. Even if Apple grows at 12% like it has during Berkshire's timeframe, the accompaniment of a P/E ratio shifting from 28 to 20 leads to very different returns than from 10 to 28.
8/ Higher prices make you feel good, and they are the consummation of past decisions, but they are just dreadful if you are looking to buy something now. This is why Munger said the next decade will be rough for many compounders.
9/ When you buy a growth stock with a P/E ratio under 20, your compounding will consist of earnings growth, dividends, and possibly P/E expansion working in your favor. But when you buy the same stock over 20x earnings, you get earnings growth + dividends subject to....
10/ a downward valuation adjustment. Having a downward adjustment rather than expansion as part of your returns is a big deal! A really big deal! And is often the difference between supercompounding and merely beating inflation by 1-3 points.
11/ The successful investor of 2021-2031 will have to do something different. He will have to locate the stocks with the P/E ratio of 10 (that could rise to 28, or at least 20!) and a double-digit growth rate to replicate Berkshire's experience with Apple.
12/ That is why buying Apple in 2021 is not being like Berkshire. If you want to be like Buffett buying Apple stock five years ago, you need to mimic the selection of a business with the similar circumstances in 2021 to Apple in 2016.
13/ Remember Buffett's line "You pay a high price for a cheery consensus." Many things that have been supercompounders are priced at cheery-consensus valuations now. Find your growth in places where you don't encounter the cheery-consensus premium. Then you'll trounce the market.
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