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Why Hold Cash: Liquidity Brings Opportunities
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in this event Morgan Stanley estimated that insurance premium increases alone would cover the losses from the World Trade Center attack2 This is the power of liquidity These reasons for keeping liquid assets also apply to the average investor First, what should you do if the stock market goes down substantially and you nd some wonderful investing opportunities Of course, you should buy stocks However, you will miss this opportunity if you are fully invested in the stock market and do not have cash or cash equivalents ready to invest Second, what should you do if you need some cash for an emergency Once again, it is good to have some cash on hand so that you do not have to sell your investments at unfavorable prices to cover unexpected costs
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Berkshire s Investments in Convertibles
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Convertible bonds and preferred stocks are similar to rent-to-own stores, where you can rent furniture or appliances and then, if you want, purchase the items Because of convertibility into common stocks, investing in convertible bonds or preferred stocks may work wonderfully when the stock price goes up If the stock price goes down, the capital and interest payment is generally still safe Put simply, it is like eating your cake and, sometimes, having another one later The best examples of convertible preferred stock investments by Berkshire Hathaway include $600 million in Gillette, $700 million in Salomon, $300 million in Champion International, and $358 million in US Airways Clearly, if Buffett had been absolutely convinced that the common stock prices would increase substantially, he would have invested in common stocks rather than in convertible preferred stocks The investment in Gillette has produced excellent returns, but the others have been sort of a mixed bag A convertible preferred stock pays a dividend at a prespeci ed rate in a manner similar to that of a bond For example, the Gillette convertible preferred stock purchased by Berkshire in 1989 carried a dividend rate of 875 percent One advantage of receiving dividends instead of interest is that about half of the dividends received by one corporation from another corporation are not taxable So, it makes sense to invest in
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risk, diversification, and when to sell
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preferred stocks rather than in bonds when the issuer is of suf ciently high quality Soon after Berkshire invested $358 million in 1989, US Airways got into trouble and, over the next ve years, incurred signi cant losses Finally, in 1994, the airline announced that it was deferring the dividend payment Based on this and other information, Berkshire decided that the fair value of the initial investment had declined by 75 percent, and therefore, the $358 million investment was worth only $895 million Fortunately, US Air s operations improved signi cantly, and Berkshire recovered its investment In the case of Berkshire s investment in Salomon, Berkshire could either have taken cash payments of $140 million or received common shares at $38 per share In 1995, Berkshire decided to take the $140 million in cash because the Solomon share price was below $38 per share at the time of maturity of part of the preferred share investment If the initial investment had been made in common stocks, the dividend amount would have been smaller, and Berkshire would have been stuck with the lower-priced common stock Berkshire acquired preferred stock in Gillette in 1989 when Berkshire came in as a white knight in response to a takeover bid by Ronald O Perelman Such opportunities to be a white knight and ensuing pro ts avail only to those who have liquidity The preferred stock was converted into common stock in 1991, and the common stock continued to perform well Without including dividends, Gillette generated a rate of return of about 14 percent per year from 1991 until it was acquired by Procter & Gamble in 2005, whereas the S&P 500 index generated a little over 7 percent per year
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