Warren Buffett warns that "prices for decent, but far from spectacular" firms have "hit an all-time high". In his latest letter to shareholders in his investment vehicle Berkshire Hathaway, he notes that price now seems "almost irrelevant to an army of optimistic purchasers".
This "purchasing frenzy" is partly due to empire-building chief executives being egged on to carry out acquisitions by fee-hungry investment bankers. Exacerbating this natural tendency of ambitious executives is "the ample availability of extraordinarily cheap debt even a high-priced deal will usually boost per-share earnings if it is debt-financed".
As far as Buffett is concerned, investors should try to avoid leverage where possible, because it leaves you vulnerable to short-term swings in the market. "It is insane to risk what you have and need in order to obtain what you don't need". He admits that an "aversion to leverage has dampened our returns over the years". But it has also enabled Buffett, and his business partner Charlie Munger, to "sleep well".
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Still, it would be a mistake for investors to go to the other extreme and shun shares in favour of bonds. "In any upcoming day, week or even year, stocks will be riskier far riskier than short-term US bonds." However, as an investor's time horizon lengthens, "a diversified portfolio of US equities becomes progressively less risky than bonds", reckons Buffett. Indeed, in many cases, holding some "high-grade bonds in an investment portfolio increase its risk". Overall, even taking into account today's relatively high stockmarket valuations, "in America, equity investors have the wind at their back".
