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Why Warren Buffett Doesn’t Matter, Lessons in Investor Sheep Herding

InvestorEducation / Learning to Invest Apr 16, 2009 - 05:11 PM GMT

By: Mike_Stathis


Best Financial Markets Analysis ArticleWithout a doubt, Warren Buffet is one of the leading investors in the world. There’s no disputing that. But let’s face it. His skills have been over-exaggerated by the media. Of more detriment, the media continues to deliver the message that what Buffett invests in matters to you. As you will see, he has been made into a god-like figure by the financial media for very precise reasons.

Journalists lacking investment expertise often reference Buffett as a way to add credibility by association. Ultimately, they utilize the Buffett “brand name” to make money. An interview with Buffett draws a large audience because the media has convinced the herd that what he says or does actually matters to them. And this translates into huge advertisement opportunities for those who sell this fantasy.

You’ve probably seen online ads telling you how you can “get in” on the “next Berkshire Hathaway” by subscribing to a service that discloses what Buffett is buying. Once again, these people are trying to make money from you by leveraging the Buffett name. They understand the marketing power behind investment celebrities. They realize the sheep will be drawn to the Buffett name because the media has brainwashed them to think they can profit by piggybacking onto his investments.

Therefore, they’ll be willing to pay for information disclosing what he has invested in. These are the same sheep that are always looking for easy money. They are the same suckers who watch CNBC and FBN. Perhaps you know some of them personally. The farce is that these services obtain Berkshire Hathaway holdings from public filings that anyone can access for free. In fact, there are many websites that list what Buffett has bought and sold. And they provide this information for free. But who cares anyway? I certainly don’t because what Buffett invests in is irrelevant for individual investors, as you shall see.

Authors who know little about investing also use the Buffett name on book titles. Or they’ll reference Buffett in their books because they know most people are looking for some shortcut to investment success. As a result, these books often sell well. In reality they rarely deliver any real value. But most readers fail to realize the uselessness of these books. They’ve been fooled into thinking these books are valuable because the author has connected them with Buffett. It’s a basic psychological trick used in branding. Sophisticated investors aren’t fooled by this gimmick.

Publishers are also in on this marketing scam. In fact, they determine book titles. Always remember this. If a person has to use big names to promote something, it almost always means they have no idea what they’re talking about. They’re simply leveraging well-known names to create a “success by association” mentality. Hollywood uses the same tactics to mask their biggest flops. Several years ago, one of the Batman sequels featured countless “big name” stars. Their marketing strategy was focused entirely on promoting these stars. I already knew it would be a dud because they were promoting the actors more than anything else. That told me the movie couldn’t stand on its own merit and needed the marketing clout of big names. I was right. Hollywood pulls this stunt all of the time. Why do you think Ben Affleck and “J-Lo” became a “hot item” a few years ago? In my opinion, their marriage was a publicity stunt (many like most Hollywood marriages) to try and get people watch their newly-released movie, Gigli. Apparently, it didn’t work too well since the movie was a huge flop. As you will recall, they divorced shortly thereafter. Why do you think most Hollywood marriages are so short? Because they are largely publicity stunts.

These are just a few examples of the typical tactics used by the media. All you have to do is look and you’ll see examples of this all over the place. If you fall for these tricks, you’re a sheep. But don’t feel bad, because I feel for the same deception a few times when I was a novice. All that matters now is that I learned from my previous ignorance. Hopefully, you’ll learn from yours.

One way to see through the smoke is to realize that what Buffett buys has no bearing on you. Certainly, Buffett is great value investor. But once you understand a few things, you might not be that impressed by him. You see, Buffett invests in businesses that generate large cash flows. This provides Berkshire Hathaway with cash on-hand to take advantage of buying opportunities. Every time his favorite stocks go down he buys more, lowering the cost basis. But he doesn’t buy risky stocks. He doesn’t need to. He buys well-known, conservative blue chips. He doesn’t know how to use market timing strategies. He doesn’t need to (although he would be a much better investor). He just buys more of his favorite gems when they decline in price.

Buffett might buy Johnson & Johnson at $70. You might follow his lead and buy some for yourself. But what happens when the stock falls to $35? Buffett will be able to buy enough to lower his cost basis to $36 if he wants. You can’t do that. Even if you had enough cash to do it, it’s unlikely you would because you hadn’t prepared for that possibility in advance.

The insurance industry is one of the best cash flow machines in the world. Now you know why Berkshire owns Geico. This cost-basis lowering approach is similar to that used by large mutual funds and pensions. Similar to Buffett, they also focus on buying large, conservative companies. Mutual fund managers aren’t able to get out of the market during sell-offs. In other words, they really don’t have any ways to reduce market risk. Instead, they use their continuous supply of cash to lower the cost basis of their holdings. During a bull market anyone can do well using that strategy. All it takes is a large pool of cash, some common sense and a conservative approach. The only problem is this strategy can be disastrous during bear markets because their supply of cash declines because investors tend sell.  

Buffett also gets exclusive investment deals. Instead of buying a stock, he might purchase the convertible bonds with warrants. This is usually a much better deal than a direct purchase of the common stock. It certainly has less risk. Or he might pay below-market rates for securities. These transactions are done privately or out of the market, shielding these opportunities from individual investors.

Buffett also buys entire companies or takes controlling interests so he can influence managerial decisions. That makes Buffett an active investor because he has direct control over the companies he invests in. We can’t do that. We are passive investors. Therefore, it’s critical for us to actively manage our securities positions. One of the best ways to do that is to reduce market risk by selling in the early stages of a bear market.  

Finally, what Buffett invests in might not be suitable for you or me because our investment objectives, horizons and financial resources are different. If you had an infinite investment horizon and hundreds of businesses that generated huge cash flows, you’d probably deliver nice returns if you were offered exclusive deals and used dollar-cost averaging for a portfolio of safe stocks like Coca-Cola, Procter & Gamble and Johnson & Johnson.

All of these considerations aside, let’s concede that Buffett is a great value investor. But he’s not so good at tech investing, derivatives, foreign currencies, emerging markets. And his investment management skills are limited to diversification and lowering the cost basis of his positions. He certainly doesn’t have expertise in shorting or market timing techniques. But remember, he doesn’t have to.

In all fairness, Buffett is very good at distressed securities analysis. Most important, he knows what he does not know and (usually) stays away from uncertainty. But even Buffett has made some big investment mistakes, as history shows. He’s only human after all. But there is one very valuable thing to learn from Buffett. Stick with what you’re good at and don’t wander into territories you’re less knowledgeable in. If you’re able to do that, you’ll have many more winners than losers over time. This approach will help you develop consistency – one of the keys to investment success.

If you have confidence in Buffett, just buy Berkshire Hathaway, plain and simple. I have no interest in Berkshire for a very good reason. It’s a value fund but it doesn’t distribute cash dividends. This violates one of the basic tenants of investing. Even Buffett would have a difficult time explaining why a value fund distributes no cash dividends. Buffett should let the investors decide whether they want him to reinvest their dividends.

You certainly aren’t going to hear the media criticize the lack of cash dividends from Berkshire Hathaway because they’re too ignorant to see anything but perfection from Buffett. Even if they realized this controversy, they wouldn’t address it because Buffett is their goose. And every time he gives an interview, he lays golden eggs in the form of ad revenues. If you want to continue this analysis, check my website and I'll show you how the media uses Buffett to make money. 

If you are a serious investor seeking to raise your investment intelligence, you should get my latest book “The Wall Street Investment Bible, Volume I.”

I want to encourage all who seek the truth and valuable guidance to follow me to my new site (coming in a few days). You won't see me pitching gold or investments to you like others. You will continue to receive nothing but unbiased top-tier insight, education and commentaries.


By Mike Stathis

Copyright © 2009. All Rights Reserved. Mike Stathis.

Mike Stathis is the Managing Principal of Apex Venture Advisors , a business and investment intelligence firm serving the needs of venture firms, corporations and hedge funds on a variety of projects. Mike's work in the private markets includes valuation analysis, deal structuring, and business strategy. In the public markets he has assisted hedge funds with investment strategy, valuation analysis, market forecasting, risk management, and distressed securities analysis. Prior to Apex Advisors, Mike worked at UBS and Bear Stearns, focusing on asset management and merchant banking.

The accuracy of his predictions and insights detailed in the 2006 release of America's Financial Apocalypse and Cashing in on the Real Estate Bubble have positioned him as one of America's most insightful and creative financial minds. These books serve as proof that he remains well ahead of the curve, as he continues to position his clients with a unique competitive advantage. His first book, The Startup Company Bible for Entrepreneurs has become required reading for high-tech entrepreneurs, and is used in several business schools as a required text for completion of the MBA program.

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Disclaimer: All investment commentaries and recommendations herein have been presented for educational purposes, are generic and not meant to serve as individual investment advice, and should not be taken as such. Readers should consult their registered financial representative to determine the suitability of all investment strategies discussed. Without a consideration of each investor's financial profile. The investment strategies herein do not apply to 401(k), IRA or any other tax-deferred retirement accounts due to the limitations of these investment vehicles.

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16 Apr 09, 21:08

Big Buffetologist, so I was amused by some of your comments. Buffett manages to get away with his aw-shucks I'm just a dumb country boy and apparently he's convinced you. Lets look at one line in your article

"But he’s not so good at tech investing, derivatives, foreign currencies, emerging markets. And his investment management skills are limited to diversification and lowering the cost basis of his positions. He certainly doesn’t have expertise in shorting or market timing techniques. But remember, he doesn’t have to"

He avoids Tech for a good reason, a market leader one year is unlikely to lead the next. Tandy, Wang, Silicon Graphics, Netscape, Lotus(though they were bought out) the list goes on and on.

Foreign currencies: I'll point you to his 2003 chairmans letter detailing his purchase of Euro based Amazon Bonds at a discount.

Emerging Markets: He's invested in South Korea and Israel

Derivatives: Have a look at his 2008 Chairmans letter and his experience selling S&P index puts(source of trouble now, but does anyone really believe European style puts will be lower on one day 2019? Plus he'll have had years to invest the money.

Finally have a look at the letter he wrote his partners on how to invest in Municipal Bonds. It is in the back of the later versions of Intelligent Investor.

Since I found your site while searching for Buffett, I suspect you used him for the very same purposes you seem to decry, to get more publicity. But I'd say your knowledge of his investment prowess is not that deep

17 Apr 09, 13:26

Im a huge Buffett fan but i must concede he was "caught short" in the current market environment.

Yes his style doesnt work for the small investor and guys like Jim Simons,Bill Dunn and many others have eclipsed his returns from 1987 onwards on smaller funds with lower drawdowns.

His greatest strength is his psychology and disclipline

17 Apr 09, 17:01
Buffett correction

His foreign currency snapshot is in the 2004 vice 2003 letter.

I would agree that his style wouldn't work for the small investor, but he also faces a very amusing problem. In 2004 he had 43billion in cash, right now a quick stock screener shows only 75 companies with market cap greater than 43 billion with BRKA at 139 billion(or 109 billion in book value).

With all the S&P rules about making investments >5% he would need some significant growth to actually show decent returns.

It's a fun theoretical problem, if his 5 billion in Goldman sachs triples in value, the extra 10 billion will only add roughly 10% to his companys' book value. As he has pointed out since 1978 size becomes an anchor to growth.

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