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Warren Buffett; How does he do it? November 11, 2008

Posted by shaferfinancial in Uncategorized.
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As regular readers know, I believe Berkshire Hathaway is a foundational stock to own.  In other words, I have built my stock portfolio around owning Berkshire Hathaway.  This is of course, exactly the opposite strategy that most financial planners suggest.  Diversification, index mutual funds, asset allocation, is all the rage in financial planning circles.  Other folks, including me, think that you can train your brain to think like Warren Buffett and find success in stock investing.  The Motley Fool guys are always touting stocks that “Warren Buffett would like!”  But can you duplicate Buffett’s strategy?

Well, yes and no.  Buffett’s early strategy has been outlined in countless books.  And many of us have attempted to train our minds to think like he did.  But Buffett had a huge problem around 1990.  When you have a rate of return of over 23% for close to 25 years, your numbers get really, really large.  Buffett, had so much cash flow in his holding company, that he started having problems buying stocks.  When he located public companies that met his guidelines, he found it impossible to purchase enough of the stock before it got out what he was doing and drove the price up.  And not enough of the stock was available to be bought.  In 1995 over 73% of Berkshire’s holdings were in publicly traded stock, that any investor could have purchased.

However, by  July of 2008, that percentage of publically traded stock owned had dropped to 25% of total assets.  What happened?  Well, he started to purchase entire businesses, lock, stock and barrel.  He also started to negotiate “sweetheart” deals with publicly traded companies.  That is what has happened here in 2008.  Deals like the $5B into Goldman Sachs,  $3B into General Electric,  $3B into Dow Chemical and $6.5B into the merger of Mars with Wrigley Jr. Co. all with special preferential terms! Twenty years ago he started to manage Berkshire in this way, but with mixed results.  But, he learned his lessons and all these deals of late have virtually no downside risk to them.  In other words, because of who he is, he can now negotiate deals that individual investors could never dream of.

So where does that leave the individual investor?  First off, his fundamental, value oriented stock selection strategy still works for individuals.  It just won’t work for someone that is moving billions  of dollars around.  Secondly,  even though he has moved on; now having only a minority of assets in publicly traded companies, the individual investor can still take advantage of his new found abilities by purchasing Berkshire Hathaway stock.

So in review, Buffett’s stock picking strategies are still available to the individual investor.  And his favorable deals are also available to the individual investor.

Note, if you want a good laugh read some of the other blogs comments on the quarterly results just announced.  People who have no idea how to analyze a company are making all sorts of claims of his demise.  Then go read his latest letter to his shareholders where he predicts everything that has happened to Berkshire this year.  Since Jan 1, 1989, Berkshire’s book value per share has risen an average of 19.9%, while the S & P 500 has risen around 10%.  So you can say his strategy of buying companies outright and negotiating special deals has done OK! 🙂 




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