Warren Buffett, the world’s most famous investor, was once well-known for using the airline industry as a cautionary tale to scare investors around the campfire. In 2007, for example, he wrote that “the worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines.”
Or in 1990, also on airlines: “In a business selling a commodity-type product, it’s impossible to be a lot smarter than your dumbest competitor.” But in the mid-2010s, airlines appeared to offer such decent value that he couldn’t resist. Turns out he should have heeded his own advice.
Warren Buffett’s second big airline mistake
Warren Buffett’s historic antipathy towards airlines stems from more than mere observation – it comes from experience. In 1989, he loaned more than $350m to USAir (a precursor to US Airways, which in turn merged with American Airlines in 2015).
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To cut a long story short, he got his money back plus dividends in 1998. The likes of you and I would probably have been happy enough, but it was a turbulent old ride for Buffett and not a deal he was at all proud of.
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Anyway. He clearly has a fascination for the things (maybe it’s because they are infrastructure related and they often look cheap). And he apparently decided that the era of capital destruction was at an end when he was tempted to buy back into the US airline industry in 2016.
By the start of this year, his investment vehicle, Berkshire Hathaway, owned roughly 10% each of four of America’s biggest airlines.
But not anymore. At the latest results meeting for Buffett reported that the fund has sold off all of its airline holdings. And this time, he didn’t make a profit or break even.
The news came as Berkshire announced a record first quarter loss of $50bn.
Now let’s be clear here. This is nothing more than a setback for Buffett. He still has bucketloads of cash – about $137bn. And whether you find his folksy style great or grating, you have to acknowledge that he is an extraordinary businessman.
So what can we learn from his latest annual shareholder meeting (or “Woodstock for capitalists”, as it’s been branded)?
Warren Buffett: “the world has changed”
There are two things I think investors need to take away from Buffett’s performance this year.
Firstly, he’s made a clear decision that “business as usual” is not coming back soon. Yes, he made the usual comments about how “nothing can basically stop America”, and how “the American magic has always prevailed and it will do so again”.
However, he sold out of his airline stakes because he thinks that, for this industry at least, “the world has changed”. Again, he hedged this by saying that he hopes he’s wrong. But at the end of the day, money talks.
“I don’t know if two or three years from now if as many people will fly as many passenger miles as they did last year. If the business comes back 70% or 80%, the aircraft doesn’t disappear. You’ve got too many planes.”
In short, Buffett does not expect a V-shaped recovery for the airline industry and he’s almost certainly correct in that. Chances are that leisure air travel could struggle right up until we’re all confident that there’s a vaccine and a successful treatment for this thing.
As for business travel – some of that demand is gone for good. It has to be. There just aren’t that many people who enjoy sitting in a hotel, then going to meetings, then coming back to the hotel and realising that, while Mumbai or Moscow or Milan might sound exotic and glamorous, you’re not doing anything you couldn’t do from a service station car park off the North Circular.
Now, you may or may not be interested in airline stocks and you may or may not want to view Buffett’s sale as a contrarian indicator. I have done no research on the sector myself, so be my guest.
But my point is, for all his optimism, Buffett recognises that some things have probably changed, and his portfolio needs to make allowances for that – even if it’s painful to swallow the change.
Why hasn’t Warren Buffett bought anything?
The second big issue is this: why hasn’t he bought anything? During the 2008 financial crisis, Buffett was a prominent source of optimism – and cash. In November 2008, he was out there telling Americans to invest in the country.
At the same time, he had uber-investment bank Goldman Sachs weeping with gratitude for agreeing to invest $5bn at a mere 10% interest, and with a whole load of other bells and whistles attached, that turned the deal into a whopping profit maker for him.
So how come – in an economy that has ground to a halt again, almost 2008-style – Buffett has been so conspicuous by his absence? This should be fertile ground for the sorts of deals that he likes to make?
The simple answer is that he’s basically been replaced by central bankers – and the Federal Reserve specifically. As Buffett himself put it: “A lot of companies that needed money… got to finance in huge ways in the last five weeks.”
As the FT reports, Buffett noted that Berkshire had been “starting to get calls” from companies looking for cash. But with the Fed’s intervention, “a number of them were able to get money in the public market frankly at terms we wouldn’t have given to them.”
So there you go. Why do these two points matter for us as investors?
One: unlike in 2008, Buffett’s optimism seems somewhat more tempered by uncertainty. Why? He’d seen a banking crisis before. Unlike many others, he knew roughly what would happen. But this – none of us have really seen anything like this before. And it’s going to have long-lasting impacts that may take us by surprise.
Two: unlike in 2008, Buffett isn’t finding anything that’s cheap enough to buy. That’s because central banks have short-circuited the market. That doesn't mean for a minute that there isn’t anything cheap out there (Buffett can’t really dabble in anything other than monster-sized companies these days). But it does show you just how swift and aggressive the response has been.
In short, as investors, we are in highly unusual territory. And we are flying blind because the price discovery mechanism has been suspended.
So be careful. Don’t act impulsively. Stick to your plan. And stay informed. On the latter, that’s why now might be a particularly good time to subscribe to MoneyWeek magazine if you don’t already – get your first six issues free (plus a free ebook on historic crashes) when you subscribe today.
