Warren Buffet’s hamburger example

One of the most classic Buffet analogies is the hamburger example. In his example Buffet says that everyone who eats hamburgers will be happy if hamburger prices were to go down for the next five years.

However, investors will not be happy if stock prices were to go down for the next five years, even if they are long – term investors. The way investors think about stock prices is at loggerheads with the way they think about anything else.

Normally, when stock prices are down, there is a plethora of bad news in general and there is a depressing mood in the markets. In such circumstances it is difficult for investors to go out and make purchases in the stock market. It is difficult to value companies and know when the economy will recover, and all this makes it very difficult to boost investor confidence.

So even though the burgers are cheap, no one wants to touch them.

Hamburgers are cheap now

If P/E multiples are anything to go by, then stocks are really cheap at this point in time. Here is a graph that shows you how the P/E of Nifty (which is a key Indian stock market index) has fared from the beginning of this century. One glance at this will tell you that stock prices, relative to their earnings are at their lowest in the last eight years or so.

PE Value Nifty Jan 08 till Oct 08
PE Value Nifty Jan 08 till Oct 08

Despite this there is very little investor interest in the stock markets and there is a negative mood in the markets. A lot of this can be attributed to the recession which is expected in the coming months. There are fears that the recession may turn into a depression and most of these companies will lose their earnings and P/E chart will adjust itself, not because the prices go up, but because the earnings will go down.

Even if that happens, for a long term investor who recognizes a deep recession or depression as part of an economic cycle, this may be the best time to buy stocks. The prices seen today are the lowest in about a decade. They may go lower but in the long run, just as we must face a recession, we will see a recovery too.

The hamburgers are cheap, but are you willing to buy them now?

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