Indirect Savings Plan

From the 1997 Chairman’s Letter:

How We Think About Market Fluctuations

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

For shareholders of Berkshire who do not expect to sell, the choice is even clearer. To begin with, our owners are automatically saving even if they spend every dime they personally earn: Berkshire “saves” for them by retaining all earnings, thereafter using these savings to purchase businesses and securities. Clearly, the more cheaply we make these buys, the more profitable our owners’ indirect savings program will be.

Furthermore, through Berkshire you own major positions in companies that consistently repurchase their shares. The benefits that these programs supply us grow as prices fall: When stock prices are low, the funds that an investee spends on repurchases increase our ownership of that company by a greater amount than is the case when prices are higher. For example, the repurchases that Coca-Cola, The Washington Post and Wells Fargo made in past years at very low prices benefitted Berkshire far more than do today’s repurchases, made at loftier prices.

At the end of every year, about 97% of Berkshire’s shares are held by the same investors who owned them at the start of the year. That makes them savers. They should therefore rejoice when markets decline and allow both us and our investees to deploy funds more advantageously.

So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls – but investors gain.” Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: “Every putt makes someone happy.”)

We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence. In recent years, the actions we took in those decades have been validated, but we have found few new opportunities. In its role as a corporate “saver,” Berkshire continually looks for ways to sensibly deploy capital, but it may be some time before we find opportunities that get us truly excited."

https://www.berkshirehathaway.com/1997ar/1997.html

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But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

There is a fundamental flaw in the oft-repeated letter.
It is, sort of, implying that over someone’s working life (say 40 years) you are a saver and during retirement (say 30 years) you are a seller. Thus you want stocks to do nothing, or drop, during your saving years and go up during your selling years.

First, if stocks actually did do nothing or drop for 40 years, you and everyone else would be in bad shape because no one would want to own any stocks, ever. Of course he didn’t say 40 years, he said 5 years.

Second, if you do save during your working years, and stocks do go up, eventually the compounding effect makes your gains on your existing balance bigger than your new deposits. You’d prefer for the price to be going up and up at this point, not down to make your new deposits have more shares. Of course this probably won’t happen in an initial 5 years of savings, but will be true over the majority of a 40 year saving period.

Mike

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Second, if you do save during your working years, and stocks do go up, eventually the compounding effect makes your gains on your existing balance bigger than your new deposits. You’d prefer for the price to be going up and up at this point, not down to make your new deposits have more shares. Of course this probably won’t happen in an initial 5 years of savings, but will be true over the majority of a 40 year saving period.

I think Buffett’s point is that even if you own, say, $1m in shares and you’re only investing $50k per year, and so low prices are only affecting the new purchases, they are not actually harming the $1m in accumulated assets, they are just making them appear to have less value. In other words, if you’re not selling your $1m in assets, you are not hurt by the low prices.

This is true if you buy shares and hold on to them for very long time. It is NOT true if you are buying low and selling high; that selling high part depends on prices occasionally being high.

dtb

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S&P500 dividend usually grows 7% annually and has an average 2% yield over the past 20 years. If stock prices stay unchanged over 20 years, dividend yield would grow to about 8%, and 40 years would be 30%, which would provide nice income for retirement, no need to sell.

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I think about this when people get excited about housing prices. People will tell you how their house has more than doubled in price in the past few years. I assume they are less excited about these gains when the tax assessor’s office talks about reassessing values. Unless these folks are planning on moving to a much lower cost of living area (and have no designs on ever returning), there’s no real benefit to watching these values surging too high. Great, my house is now worth X but now the nicer houses in the neighborhood to which I once aspired as now worth 3X. First-time home buyers have it worse than ever.

Now we have to worry about prices popping and going lower. Good for first-time home buyers but not for anyone who bought during a run-up. It would have been best if prices had stayed mostly flat to single digit returns for all involved. Make your returns in the market. With BRK.

SD

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S&P500 dividend usually grows 7% annually and has an average 2% yield over the past 20 years.
If stock prices stay unchanged over 20 years, dividend yield would grow to about 8%, and 40 years would be 30%,
which would provide nice income for retirement, no need to sell.

Ummmm…no?
Yes, the dividend yield has averaged a number extremely close to 2% in the last 20 years.
But dividends don’t usually grow at 7%/year, nowhere near that.
Unless you’re assuming high inflation, which would make the number meaningless. You can’t live on income that rose only in nominal terms.

S&P 500 dividends have risen at inflation+2.23%/year in the last 50 years.
And that’s with today as the endpoint, which is cyclically very very elevated.
If we take that as a typical growth rate, and start with the S&P yield now of around 1.8%,
then in 20 years you’d have a real yield of about 2.8% of the initial investment.
After 40 years you’d have a real annual yield of about 4.35% of the initial investment–a fair bit lower than 30%.

As should be pretty obvious, total dividends grow at roughly the same rate of growth of sales and profits over long time frames.
All three of those rates are close to the rate of increase of GDP.

Jim

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S&P 500 dividends have risen at inflation+2.23%/year in the last 50 years.
And that’s with today as the endpoint, which is cyclically very very elevated.
If we take that as a typical growth rate, and start with the S&P yield now of around 1.8%,
then in 20 years you’d have a real yield of about 2.8% of the initial investment.
After 40 years you’d have a real annual yield of about 4.35% of the initial investment–a fair bit lower than 30%.

Thanks for more accurate data. I only look at the past 20 years when the S&P500 index grew about 7% annually, and assume the yield stayed unchanged near 2%, then dividend should also grow 7% annually.

Here is a table of dividend growth rates since 1989
https://www.multpl.com/s-p-500-dividend-growth/table/by-year…

And the corresponding chart and statistics
https://www.multpl.com/s-p-500-dividend-growth

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Another way to look at it:

S&P 500 index was near 110 in 1982
https://www.google.com/search?q=S%26P+500&rlz=1C1OKWM_en…

Today, S&P index is 3911 with dividend yield of 1.58%. If the index stayed unchanged since 1982, the dividend yield would have been 3911/110 * 1.58% = 56%. Even higher than I thought, something wrong here?

Today, S&P index is 3911 with dividend yield of 1.58%. If the index stayed unchanged since 1982, the dividend yield would have been 3911/110 * 1.58% = 56%.
Even higher than I thought, something wrong here?

Sounds surprising, but a lot of it is simply the coincidence that the S&P was at almost its cheapest multiples in the last 80 years, precisely 50 years ago at that start date.
The starting dividend yield in June 1982 was 6.31%, about 3.5 times today’s yield.

Plus, of course, a dollar doesn’t buy what it used to.
Very close to a third of the purchasing power back then.

50 years ago, measured in money of the day:
Dividends $6.89, Earnings $14.73, Dividend yield 6.31%, earnings yield 13.5%

50 years ago, in today’s dollars:
Dividends $20.76, Earnings $44.39, Dividend yield 6.31%, earnings yield 13.5%

Now:
Dividends $65.41, Earnings $197.87, Dividend yield 1.78%, earnings yield 5.38%

Real rate of growth
Dividends 2.32%
Earnings 3.03%

All figures are without any cyclical adjustment.
Both earnings and dividends are cyclically high at the moment, but it shows the general idea:
The business results have been pretty normal and steady, bar the squiggles induced by the business cycle.
The returns have varied widely, but really only because valuation multiples have varied widely.

As an aside, it’s quite amazing what earnings have done just lately.
As-known-and-reported trailing four quarter S&P 500 earnings are up 24% after inflation from the pre-pandemic peak in mid 2020. (42% higher in nominal terms)
This too shall pass, I expect.

Jim

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This is just to illustrate Buffett’s point that if you keep buying stocks, you would want the prices to stay low. This is true even after retirement when you are no longer buying. As a hypothetical example, if one had accumulated $200k of stocks at the prices of 1982, the dividend yield would have been $112k annually, and no one would want or need to sell.

Sounds surprising, but a lot of it is simply the coincidence that the S&P was at almost its cheapest multiples in the last 80 years, precisely 50 years ago at that start date.
The starting dividend yield in June 1982 was 6.31%, about 3.5 times today’s yield.

June 1982 was 40 years ago, or I’m a lot older than I thought!

Rob

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June 1982 was 40 years ago, or I’m a lot older than I thought!

40, 50, who can remember that far back? As you say, we’re old!

Sorry, I read the wrong line from my table.

But the general idea is the same: there has been a lot of inflation since then, and dividend yields were very high back then compared to recent years.
Those two factors explain why at first glance it appears that dividends have risen a lot more than they really have.

What rate is a reasonable expectation?
And excellent first approximation is that the dividends will rise at the same rate as GDP over long time periods.
There is only so much importing and exporting going on, and that changes relatively slowly on a net basis.
So divergences are primarily driven by the share of the economy going to corporate profits versus competing constituencies like labour and taxes.
That share has to remain in some kind of bounded range forever.
It’s a direct mathematical consequence that the longer the time frame in question the closer the two rates will match.

Jim

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June 1982 was 40 years ago, or I’m a lot older than I thought!

40, 50, who can remember that far back? As you say, we’re old!


But the general idea is the same: there has been a lot of inflation since then

I am sure old.

Sure has. When I started driving in 1961, it took about two ounces of silver to fill the tank. Now it takes only one ounce of silver to do that, and my present car has about the same capacity as the one I had when I started driving.

In US dollars, IIRC gasoline cost about $0.21/gallon for high test (102 octane) gasoline back then. Now it is around $5/gallon for regular gas. So using the “silver standard” gasoline has dropped about 50% in around 60 years, whereas using the US dollar as an index, gasoline has gone up around 25 times.