Saturday, August 16, 2003

Cheap Shot Against Buffett

Donald Luskin expresses dismay today about Arnold Schwarzenegger's choice of legendary investor, Warren Buffett, to head his economic team. Buffett, obviously no supply-sider, has been outspoken in his opposition to President Bush's tax cuts as a means to stimulate the economy.

Sure, Schwarzenegger's choice deserves to raise some eyebrows, but Luskin goes too far in his unfavorable characterization of Buffett. For example, describing the most successful investor of the last forty years as someone who "made some smart investments in razor blades" (a reference to Buffett's long-standing interest in Gillette) is a cheap shot.

Moreover, Buffett's vocal opposition to stock options is not by itself destructive of California's entrepreneurial tech culture. It has become clear to anyone who seeks to understand the value of companies that paying an expense and not logging it as an expense on the books is not a great method of corporate accounting.

And if Buffett argues that options discourage corporations from paying dividends, Berkshire Hathaway's own lack of a dividend payout does not make Buffett a hypocrite as Luskin implies. Buffett does not keep earnings to furnish a lavish life; indeed he lives in the same house in Omaha, Nebraska that he purchased 35 years ago. He does not keep earnings to pay out rich options packages to himself and other executives of Berkshire. Rather he "retains" earnings in order to reinvest them and continuously exploit new opportunities for his shareholders. Over his professional life, he has proven that he has the ability to provide his investors with a greater return on earnings than anyone else, and his investors have been more than happy to forego cash dividends in exchange for the opportunity to put more of their money in Buffett's capable hands. As Buffett himself says, "[Earnings retention is justified when] capital retained produces incremental earnings equal to, or above, those generally available to investors."

Most corporations should pay their earnings back as dividends because they do not have Warren Buffett on staff using cash efficiently and providing a superior return on capital. Besides, when you invest in Berkshire Hathaway, you understand that you are giving your money to Warren Buffett so that he can go out and exploit other opportunities to make money on your money. When you invest in General Motors, by contrast, you are giving your money to a corporation that makes cars so that you can enjoy the profits of that specific product and business. You're not counting on General Motors to invest earnings that they do not pay out as dividends in any way except to facilitate the automobile manufacturing business. You do not expect General Motors to retain earnings in order to build an investment portfolio with your potential dividends, because General Motors is not in the business of "allocating capital" as Berkshire Hathaway is. Luskin's piece ignores this difference.

Being a brilliant investor does not automatically qualify one as a capable economic policy analyst or advisor. In fact, the best investors often boast about not even caring about larger economic issues, implying that such concerns distract them from focussing on an individual company's profitability and the value of its shares. Another legendary investor, Peter Lynch, for example, has been quoted as saying that if you spend fifteen minutes per year studying the general economy, you've spent ten minutes too many.

One may indeed argue with Buffett's opposition to tax cuts and his opposition to reducing the taxation on equity dividend distributions. One may also seriously question Schwarzenegger's judgment in his choice for these reasons. Nevertheless, Luskin's piece substitutes hyperbole for serious argument.

It's nice to see that the Wall St. Journal isn't giving a successful investor a pass, and that it is taking politics more seriously than investment capability. But one expects more serious arguments than Luskin's piece provides. If Republicans want to question Buffett (and well they should), they should do so on the merits (or lack thereof) of Buffett's arguments, not by implying that he is a hypocrite.


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