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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Buffets Berkshire Hathaway New Investing Lessons for 2010

InvestorEducation / Learning to Invest Mar 02, 2010 - 08:55 AM GMT

By: Nilus_Mattive

InvestorEducation

Best Financial Markets Analysis ArticleIt’s no secret that I’m a huge fan of Warren Buffett (and his business partner Charlie Munger, too). That’s why I eagerly await the release of Berkshire Hathaway’s annual shareholder reports.


The latest version — released just a few days ago and available online in its entirety — is really written to a bigger audience than usual. After all, Berkshire ‘B’ shares were recently split into much more affordable units and their subsequent addition to the S&P 500 index means that practically anyone with a basic stock index fund is now a Berkshire shareholder. Plus, the company’s acquisition of Burlington Northern means another 65,000 owners added to the Berkshire roster.

Of course, even if you don’t own Berkshire, the insights in the company’s letters are absolutely wonderful. So I’d like to spend a little time today telling you not just some of the most important things that were said in Berkshire’s latest missive but also how you can apply the lessons to your own portfolio and financial life.

Let’s start with …

Four of Berkshire Hathaway’s Guiding Principles

This is one of the first things Buffett covers in the 2009 letter, and I think the points made are absolutely applicable to each one of us.

Principle #1: Focus on areas that are relatively easy to understand and predict. Buffett notes that it’s easy to identify many investment areas that will grow quickly, but it’s not as easy to predict how quickly those opportunities will evolve or how individual companies will fare over the years. His examples include the auto industry and television manufacturers, and I suspect he would place many of today’s technology firms in the same category.

The idea here is that many investment possibilities — while packed with huge profit potential — are also very fleeting. Others, while a bit less exciting, have relatively certain longevity. For example, companies that operate in very established, hard-to-enter industries.

In my view, this one is directly applicable to all of our portfolios … and it is certainly something I consider when making recommendations in Dividend Superstars. Most of our positions are in world-class firms with many decades of success both under their belts and likely ahead as well.

Principle #2: “Never become dependent on other people’s money.Buffett is speaking to the fact that Berkshire Hathaway doesn’t want to depend solely on financing to do its deals. Quite the opposite — the company carries a large cash hoard that it can use to pursue opportunities — especially at times when the rest of the world desperately needs financing, such as the credit crunch we recently experienced.

While doing so — especially in this low-interest-rate environment — does crimp the firm’s performance a bit, over the longer-term it allows Berkshire to pounce when conditions warrant. It’s precisely why Buffett was able to lock down those sweet Goldman and GE preferred share during the recent crisis.

And equally important is the fact that — according to Buffett — always having a cash hoard allows him to sleep well.

Buffett and Munger are probably the most successful investing team of all time!
Buffett and Munger are probably the most successful investing team of all time!

In my view, every single one of us should adhere to this same simple rule — always keeping a cash position provides financial flexibility to your portfolio and also gives you the confidence to live life with less worry about minor bumps in the road.

My suggestion is to both keep an emergency cash fund completely separate from your investment portfolio plus a cash position ready to be deployed when new opportunities present themselves. Again, this is precisely what I’m doing in Dividend Superstars at present — we have about 50 percent of our holdings in cash for both downside protection and to be used when attractive new opportunities present themselves.

Buffett is also quick to point out that he wants Berkshire’s liquidity to be “constantly refreshed by a gusher of earnings from our many and diverse businesses.” More on this in a moment. First …

Principle #3: Don’t micromanage. Buffett says Berkshire keeps the managers of its subsidiaries on rather long leashes. And while he admits that this sometimes means problems get recognized late in the game, he believes the benefits of letting talented people perform freely outweighs the downside.

While you may not manage even one business — let alone a bunch of them — I think this same rule applies to the investments within your portfolio. As long as you’ve selected quality to begin with, there’s no reason to continually tweak your positions. Let them do what they’re meant to do.

By all means, keep a watchful eye on things and cut dead weight when warranted … but trust in your initial judgments until you have a strong reason to believe otherwise!

Principle #4: “Make no attempt to woo Wall Street.” In this final guiding principle, Buffett points out that Berkshire doesn’t want in-and-out investors, but rather partners who are looking for a long-term relationship. Once again, I think this is applicable to all of us. As shareholders, we should invest in firms that we want to own for the long haul.

And at the same time, we should realize that — as Buffett points out — mainstream media sources are generally not the best places to get our investment information and Wall Street “wisdom” is anything but.

Now, Let’s Look at the Kind of Businesses That Berkshire Owns!

The mainstream news stories love talking about Berkshire’s individual positions, especially the ones that have gone up or down the most.

Me? I’d rather talk about the types of businesses Buffett & Co. gravitate toward. After all, it’s more helpful to understand WHY he buys than WHAT he buys … especially since some of his positions were purchased many moons ago.

The first and most obvious category would be insurance companies. Buffett likes these holdings mostly because they provide him with steady cash flows that he can use to invest elsewhere.

We currently own a very attractive niche insurance company in Dividend Superstars, and it’s no secret that I love cash-gushing business, too.

Utilities are attractive because they provide relatively predictable cash flows …
Utilities are attractive because they provide relatively predictable cash flows …

Regulated utilities are the second. Again, the idea here is predictability and major cash flows. Buffett’s big position here comes via his 89.5 percent interest in MidAmerican Energy Holdings — which owns a number of traditional utilities as well as pipeline operations. And again, I follow a similar strategy in my newsletter — where I’m currently recommending three domestic utilities, one foreign play, and two different pipeline companies.

Berkshire also owns a diverse array of other businesses, both outright and via investments. At first, the names seem unrelated — but then you realize that they’re all conservatively managed, tend to boast recognizable brands, and are focused on products or markets that are relatively easy to understand. No surprise based on the principles I outlined above!

I’m frequently praising the power of well-established, streamlined businesses here in Money and Markets, so very little else needs to be said.

Last but not least are Berkshire’s financial firms. Buffett owns Clayton Homes, which is largely a financing operation under the surface. His recently-purchased 50 percent stake in Berkadia Commercial Mortgage also gave him a huge position in the commercial mortgage market. Plus he has investments in companies like American Express, U.S. Bancorp, Wells Fargo, and others.

This is the one area where I ‘m currently diverging from Berkshire’s approach. It’s not because I don’t think there’s money to be made in these businesses, but rather because I feel the risks are still rather large and because Buffett’s huge war chest and special arrangements often give him an above-average chance of success in these areas.

But the bottom line is that even without the unique advantages and pieces of information Buffett’s privy to, we can all learn a lot from his overall approach to investing.

In fact, I think Berkshire’s back-to-basics, level-headed, common sense approach has been the biggest reason its book value has risen at a compounded annual rate of 20.3 percent over the last 45 years … something we should all keep in mind as the markets continue to gyrate!

Best wishes,

Nilus

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


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