Warren buffet

Warren Buffett is the world's most successful investor. He started out with money from his three newspaper routes in Washington DC and other small money-making activities. He saved his money and invested it.

Here are the amazing figures:

Age 20, end of 1950 has $9,804 (childhood savings and investments)

Age 21, end of 1951 has $19,738 (a good year in the markets!)

Age 26, 1956 has about $174,000

Age 76, 2006 has about $44,000,000,000 ($44 billion) and begins to give his fortune to Charities. Compounded gain in wealth per year since 1956 was about 28% per year.

Buffett only ever worked for anyone else for about 4 or 5 years. Beginning in 1956 he generated his wealth strictly from investments (which included running an investment partnership and soon included buying whole companies rather than just stocks and bonds). As president of his investment company Berkshire Hathaway his salary has been $200,000 per year for many many years with no bonuses or stock options added to that.

The point is, the man generated $44 billion in wealth from a standing start (no significant inheritance) simply through astute investing. If that does not motivate you as an investor, I don't know what would.

Maybe, just maybe, we can all learn something from Warren Buffett. Maybe, just maybe, his methods and teachings are worth following.

Did you know that Buffett told the investment world in 1999 that stocks were over-valued? He demonstrated that stocks could not return the double-digit returns that investors were expecting. The stock market had been rising rapidly (with some bumps along the way) since 1982. Most investors thought that the internet and the technology boom would allow the market to continue to deliver double digit returns. Buffett pointed out why double digit returns were very unlikely.

At a conference in August 1999, and as publised in Fortune magazine in November 1999, Buffett pointed out that while in the 17 years since 1982, the DOW was up astoundingly from 875 to 9181, in the prior 17 years from the end of 1964 to the end of 1981, the Dow had ended up exactly 1 point from 874 to 875.

Buffett explained that the poor performance in the 1965 through 1981 period was primarily due to rising interest rates and that, conversely, the out-performance in the 17 years ending 1999 was primarily due to declining interest rates. The U.S economy had grown in both periods (370% in the poor-returns period, somewhat under 300% in the mega returns period).

Buffett pointed out that in the long-run earnings grow at about the rate of nominal GDP growth. He then suggested that a reasonable forecast for GDP growth was 5% (3% real growth and 2% for inflation). Adding 2% for dividends he concluded that the overall U.S. stock market was unlikley to return more than 7% per year in the longer term strating from 1999. In fact given the high value of the market in 1999, Buffett's best guess for the return in the 17 years after 1999 was just 6%. Less than half of what most investors were used to and expecting! And he believed it was just as likelyto be less than 6% as more.

In 1999 Buffett's article was met with great skepticism, (he was yesterday's man etc.) investors kept on bidding stock prices up, until they crashed in 2001.

As of 2009 it looks like Buffett may even have been optimisitic - as indeed he said he might be. The Dow is right now at almost exactly the same level as it was in 1999 and the Dow's total return has therefore come only from dividends, perhaps 2% or 2.5% per year. So the DOW has got to rise quickly in the next seven years just to give the 6% that Buffett had guessed it might.

So the point is, Buffett was right in 1999, his simple anlysis has proved to be valid.

In late 2001 Buffett followed up his 1999 FORTUNE magazine article and I was lucky enough to see it. I also at that time dug up the original 1999 article.

Starting in 2002 I have regularly used Buffett's method to try to calculate whether or not the DOW and the S&P 500 were fairly valued or not.

As Buffett said in his 1999 article this is not meant to be a way to predict where the market is going in the short term. But it can help us regognise when the market appears to be over-priced or under-priced. In the long-trun, investing more money when the market seems under-valued is likely to be a winning strategy.

Just today I have updated my analysis of the valuation of the Dow and the S&P 500 indexes, using this Buffett-style analysis. In these latest updates I have added additional charts of GDP versus earnings (a relationship used by Buffett) and I believe that these charts can help us understand the "normalized" earnings on the DOW and the S&P 500 and therefore to understand the attactiveness (or lack thereof) of the stock markets at this time.