What Would Warren Do?
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Sukumar.N
Nov 26, 2008, 5:06:53 AM11/26/08
to Kences1
What Would Warren Do?
Or better yet - what is the Oracle up to in this market, and can you
do the same?
Warren Buffett has already told the world what he's doing in this
frightful market. The Oracle of Omaha proudly proclaimed that he's
"been buying American stocks" with his personal funds.
But it should also be noted that Buffett has been putting his
investors' money on the line as well. After sitting on piles of cash
for several years and lamenting the lack of attractive opportunities,
Buffett has made several key acquisitions through his investment
conglomerate, Berkshire Hathaway, culminating in a flurry of late-
September and early-October deals.
In just a two-week span, Buffett picked up Constellation Energy for
the relative bargain price of $4.7 billion. He bought $5 billion in
preferred stock from Goldman Sachs, receiving a fat 10% yield. And he
purchased $3 billion in preferred shares of GE, also yielding 10%.
This doesn't mean Buffett is saying go out and buy Goldman or GE (GE)
stock. In fact, there are plenty of reasons why you shouldn't try to
follow his lead, not the least of which is the fact that Berkshire
gets deals that individuals simply can't.
But that's not the point. The opportunity here is to pick up some
valuable investing wisdom from the greatest practitioner alive. In
this spirit, here's what I think you can learn from Buffett's moves:
Be Greedy When Others Are Fearful
===========================
It's the most famous of all Buffett-isms: "Be fearful when others are
greedy and greedy when others are fearful." Today there's ample
evidence that people are scared, as fund investors have been redeeming
record amounts of money from their stock portfolios.
By contrast, Buffett is putting his money to work. Berkshire's cash
balance, by my estimate, is at its lowest level in recent memory.
Now, this doesn't mean the market will turn around tomorrow. But
Buffett's point is that this is not the time to flee U.S. stocks. In
fact, now is a great time to be looking for shares of high-quality
firms that have been beaten down to affordable levels.
For examples of attractively priced industry leaders, see the
suggestions to the right.
Don't Be Hobbled by Past Mistakes
==========================
Buffett's investment in Goldman Sachs (GS) was surprising to many,
given his frequent digs at Wall Street's casino culture and a
problematic investment he made in Salomon Brothers.
In 1987, Buffett bought a stake in Salomon to ward off a hostile
takeover, but the firm nearly collapsed amid a bond bid-rigging
scandal a few years later, and Buffett had to step in as interim
chairman.
Although the investment eventually worked out - Salomon was bought by
Travelers, which merged with Citicorp to form Citigroup (C) - it's
safe to say that it was a longer and harder road than he had
anticipated.
Still, Buffett understood that investment banking, for all its recent
woes, is an attractive business if managed properly. The group of top-
tier firms is fairly small, and it would be hard for a new competitor
to break into the business, which gives Goldman Sachs tremendous
bargaining power over its customers.
There's an important lesson in this for individual investors. Just
because many financial stocks in your portfolio have imploded
recently, it doesn't mean you should sell out of this sector entirely
- or turn your back on these stocks for good.
Don't Fall in Love With Your Stocks
==========================
Buffett is famous for having said that his favorite holding period is
"forever." But he will sell a stock he loves if conditions warrant.
For example, late last year, as crude-oil prices were approaching $100
a barrel, Buffett jettisoned his stake in PetroChina (PTR).
Why? After multiplying more than fivefold since he bought it a few
years earlier, PetroChina shares had reached fair value, so he sold.
Since he cashed out, PetroChina shares have been cut in half.
Chalk this up to a lesson the Oracle learned in the late '90s. As he
admitted in 2003, "...I made a big mistake in not selling several of
our larger holdings during the Great Bubble."
Buffett similarly made what may be one of his best decisions when he
sold Berkshire Hathaway's long-held stake in Freddie Mac (FRE) in
2000. He's never written about exactly why, but he noted presciently
at his 2001 annual shareholder meeting that Freddie Mac's "risk
profile had changed."
Keep Your Powder Dry
=================
While the rest of the world gorged on cheap credit, Buffett maintained
Berkshire's conservative profile. This hindered his returns when times
were good, but having lots of cash on hand enabled Buffett to snap up
once-in-a-lifetime deals, like Constellation Energy (CEG).
Buffett, who owns several utilities, jumped on Constellation in
September after its shares tumbled from around $60 to his purchase
price of $26.50 in a mere matter of days. The result: He nabbed a
company that produces nearly $1 billion in earnings a year for less
than $5 billion.
Now, you may not be in a position to keep $40 billion in the bank. But
as Buffett showed, it's smart to have some cash on hand for
opportunistic purchases. What's more, there's nothing wrong with being
disciplined enough to turn your back on stocks that you're not 100%
confident in. That's sage advice.
Why He's Warren Buffett — and You're Not
================================
If investing were as simple as mimicking Warren Buffett, then all
you'd have to do to retire rich would be to download a free copy of
the Berkshire Hathaway annual shareholder letter and shadow the
Oracle's moves.
Given that you're reading this article instead of relaxing at your
seaside villa, it's clear copying Buffett is no easy task. So as you
marvel at the Sage, keep the following in mind:
Warren Can Strike Deals You Can't
==========================
Buffett's reputation and Berkshire's financial heft are enormous
advantages that regular investors simply don't share. Take his recent
investment in Goldman Sachs (GS). It was made in preferred stock that
was offered only to Berkshire and pays a 10% fixed yield.
That's twice what Uncle Sam is initially earning on the preferred
shares it got from Goldman in exchange for injecting capital into the
bank. But chalk that up to the Buffett premium. Firms want the Oracle
to invest in them for his seal of approval.
Berkshire's purchase of Constellation Energy offers a great example.
Constellation's shares had fallen 75% from their highs because the
market was worried about the financial health of the company's energy-
trading operations.
If you or I bought the stock at that level, we would have been making
a bet that Constellation would pull through. But we would not have
been able to affect the odds. However, Berkshire's financial strength
and Buffett's name assured Constellation's survival, making the
investment more valuable as soon as Warren bought the company.
Warren Is Smarter Than You Are
========================
Many casual observers assume that Buffett simply buys great companies
and hangs on to them. Simple, right? But the real key to Buffett's
success is far more complicated.
Buffett has created enormous value for Berkshire by buying all kinds
of securities, from common stock and preferred shares to currencies,
distressed debt and options.
He has also made money through merger arbitrage and fixed-income
arbitrage. These are all areas that only the most sophisticated
investor should dabble in.
Why Mimic Warren When You Can Hire Him?
==================================
Your best bet for benefiting from Buffett's wisdom is the most
obvious: Buy Berkshire Hathaway (BRK.B) stock.
It's really an investment company. But unlike a fund, it doesn't
charge annual management fees. Buffett has deployed a lot of cash into
attractive deals lately, which should add value for years to come.
N.Sukumar
Research Analyst
www.kences1.blogspot.com
Or better yet - what is the Oracle up to in this market, and can you
do the same?
Warren Buffett has already told the world what he's doing in this
frightful market. The Oracle of Omaha proudly proclaimed that he's
"been buying American stocks" with his personal funds.
But it should also be noted that Buffett has been putting his
investors' money on the line as well. After sitting on piles of cash
for several years and lamenting the lack of attractive opportunities,
Buffett has made several key acquisitions through his investment
conglomerate, Berkshire Hathaway, culminating in a flurry of late-
September and early-October deals.
In just a two-week span, Buffett picked up Constellation Energy for
the relative bargain price of $4.7 billion. He bought $5 billion in
preferred stock from Goldman Sachs, receiving a fat 10% yield. And he
purchased $3 billion in preferred shares of GE, also yielding 10%.
This doesn't mean Buffett is saying go out and buy Goldman or GE (GE)
stock. In fact, there are plenty of reasons why you shouldn't try to
follow his lead, not the least of which is the fact that Berkshire
gets deals that individuals simply can't.
But that's not the point. The opportunity here is to pick up some
valuable investing wisdom from the greatest practitioner alive. In
this spirit, here's what I think you can learn from Buffett's moves:
Be Greedy When Others Are Fearful
===========================
It's the most famous of all Buffett-isms: "Be fearful when others are
greedy and greedy when others are fearful." Today there's ample
evidence that people are scared, as fund investors have been redeeming
record amounts of money from their stock portfolios.
By contrast, Buffett is putting his money to work. Berkshire's cash
balance, by my estimate, is at its lowest level in recent memory.
Now, this doesn't mean the market will turn around tomorrow. But
Buffett's point is that this is not the time to flee U.S. stocks. In
fact, now is a great time to be looking for shares of high-quality
firms that have been beaten down to affordable levels.
For examples of attractively priced industry leaders, see the
suggestions to the right.
Don't Be Hobbled by Past Mistakes
==========================
Buffett's investment in Goldman Sachs (GS) was surprising to many,
given his frequent digs at Wall Street's casino culture and a
problematic investment he made in Salomon Brothers.
In 1987, Buffett bought a stake in Salomon to ward off a hostile
takeover, but the firm nearly collapsed amid a bond bid-rigging
scandal a few years later, and Buffett had to step in as interim
chairman.
Although the investment eventually worked out - Salomon was bought by
Travelers, which merged with Citicorp to form Citigroup (C) - it's
safe to say that it was a longer and harder road than he had
anticipated.
Still, Buffett understood that investment banking, for all its recent
woes, is an attractive business if managed properly. The group of top-
tier firms is fairly small, and it would be hard for a new competitor
to break into the business, which gives Goldman Sachs tremendous
bargaining power over its customers.
There's an important lesson in this for individual investors. Just
because many financial stocks in your portfolio have imploded
recently, it doesn't mean you should sell out of this sector entirely
- or turn your back on these stocks for good.
Don't Fall in Love With Your Stocks
==========================
Buffett is famous for having said that his favorite holding period is
"forever." But he will sell a stock he loves if conditions warrant.
For example, late last year, as crude-oil prices were approaching $100
a barrel, Buffett jettisoned his stake in PetroChina (PTR).
Why? After multiplying more than fivefold since he bought it a few
years earlier, PetroChina shares had reached fair value, so he sold.
Since he cashed out, PetroChina shares have been cut in half.
Chalk this up to a lesson the Oracle learned in the late '90s. As he
admitted in 2003, "...I made a big mistake in not selling several of
our larger holdings during the Great Bubble."
Buffett similarly made what may be one of his best decisions when he
sold Berkshire Hathaway's long-held stake in Freddie Mac (FRE) in
2000. He's never written about exactly why, but he noted presciently
at his 2001 annual shareholder meeting that Freddie Mac's "risk
profile had changed."
Keep Your Powder Dry
=================
While the rest of the world gorged on cheap credit, Buffett maintained
Berkshire's conservative profile. This hindered his returns when times
were good, but having lots of cash on hand enabled Buffett to snap up
once-in-a-lifetime deals, like Constellation Energy (CEG).
Buffett, who owns several utilities, jumped on Constellation in
September after its shares tumbled from around $60 to his purchase
price of $26.50 in a mere matter of days. The result: He nabbed a
company that produces nearly $1 billion in earnings a year for less
than $5 billion.
Now, you may not be in a position to keep $40 billion in the bank. But
as Buffett showed, it's smart to have some cash on hand for
opportunistic purchases. What's more, there's nothing wrong with being
disciplined enough to turn your back on stocks that you're not 100%
confident in. That's sage advice.
Why He's Warren Buffett — and You're Not
================================
If investing were as simple as mimicking Warren Buffett, then all
you'd have to do to retire rich would be to download a free copy of
the Berkshire Hathaway annual shareholder letter and shadow the
Oracle's moves.
Given that you're reading this article instead of relaxing at your
seaside villa, it's clear copying Buffett is no easy task. So as you
marvel at the Sage, keep the following in mind:
Warren Can Strike Deals You Can't
==========================
Buffett's reputation and Berkshire's financial heft are enormous
advantages that regular investors simply don't share. Take his recent
investment in Goldman Sachs (GS). It was made in preferred stock that
was offered only to Berkshire and pays a 10% fixed yield.
That's twice what Uncle Sam is initially earning on the preferred
shares it got from Goldman in exchange for injecting capital into the
bank. But chalk that up to the Buffett premium. Firms want the Oracle
to invest in them for his seal of approval.
Berkshire's purchase of Constellation Energy offers a great example.
Constellation's shares had fallen 75% from their highs because the
market was worried about the financial health of the company's energy-
trading operations.
If you or I bought the stock at that level, we would have been making
a bet that Constellation would pull through. But we would not have
been able to affect the odds. However, Berkshire's financial strength
and Buffett's name assured Constellation's survival, making the
investment more valuable as soon as Warren bought the company.
Warren Is Smarter Than You Are
========================
Many casual observers assume that Buffett simply buys great companies
and hangs on to them. Simple, right? But the real key to Buffett's
success is far more complicated.
Buffett has created enormous value for Berkshire by buying all kinds
of securities, from common stock and preferred shares to currencies,
distressed debt and options.
He has also made money through merger arbitrage and fixed-income
arbitrage. These are all areas that only the most sophisticated
investor should dabble in.
Why Mimic Warren When You Can Hire Him?
==================================
Your best bet for benefiting from Buffett's wisdom is the most
obvious: Buy Berkshire Hathaway (BRK.B) stock.
It's really an investment company. But unlike a fund, it doesn't
charge annual management fees. Buffett has deployed a lot of cash into
attractive deals lately, which should add value for years to come.
N.Sukumar
Research Analyst
www.kences1.blogspot.com
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