Posted by: Dirk | August 15, 2007

Following Warren Buffett

The NY Times today reminded its readers of the economic relevance of the long-run price-to-earnings ratio. It was invented by Benjamin Graham and David L. Dodd in 1934 (The classic 1940 edition is avaliable from the publisher). Among those who remembered it is Robert J. Shiller, whose new edition of Irrational Exuberance I recently reviewed. According to the calculations done by him and John Y. Campbell, the long-run price-to-earnings ratio stands at 26.96. That’s higher than ever, at least the highest since 130 years.Among those who followed the strategy is billionaire Warren Buffett. He recently had to publish his new acquisitions, among which were Dow Jones and Bank of America. The (short-run) price-to-earnings ratio of Bank of America is 10.19, that of Dow Jones 14.36, while Google’s stands at 42.89, just to compare with. So it seems to me that Warren Buffett still follows his old strategy. Probably he does not believe himself what some investors see as a new era of rapid profit growth, as reported by the NY Times’ David Leonardt. Leonardt also remarks that investments that depend on the words ‘new era’ don’t usually do so well.

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