Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21
UK Covid-19 Booster Jabs Moderna, Pfizer Are They Worth the Risk of Side effects, Illness? - 22nd Nov 21
US Dollar vs Yields vs Stock Market Trends - 20th Nov 21
Inflation Risk: Milton Friedman Would Buy Gold Right Now - 20th Nov 21
How to Determine if It’s Time for You to Outsource Your Packaging Requirements to a Contract Packer - 20th Nov 21
2 easy ways to play Facebook’s Metaverse Spending Spree - 20th Nov 21
Stock Market Margin Debt WARNING! - 19th Nov 21
Gold Mid-Tier Stocks Q3’21 Fundamentals - 19th Nov 21
Protect Your Wealth From PERMANENT Transitory Inflation - 19th Nov 21
Investors Expect High Inflation. Golden Inquisition Ahead? - 19th Nov 21
Will the Senate Confirm a Marxist to Oversee the U.S. Currency System? - 19th Nov 21
When Even Stock Market Bears Act Bullishly (What It May Mean) - 19th Nov 21
Chinese People do NOT Eat Dogs Newspeak - 18th Nov 21
CHINOBLE! Evergrande Reality Exposes China Fiction! - 18th Nov 21
Kondratieff Full-Season Stock Market Sector Rotation - 18th Nov 21
What Stock Market Trends Will Drive Through To 2022? - 18th Nov 21
How to Jump Start Your Motherboard Without a Power Button With Just a Screwdriver - 18th Nov 21
Bitcoin & Ethereum 2021 Trend - 18th Nov 21
FREE TRADE How to Get 2 FREE SHARES Fractional Investing Platform and ISA Specs - 18th Nov 21
Inflation Ain’t Transitory – But the Fed’s Credibility Is - 18th Nov 21
The real reason Facebook just went “all in” on the metaverse - 18th Nov 21
Biden Signs a Bill to Revive Infrastructure… and Gold! - 18th Nov 21
Silver vs US Dollar - 17th Nov 21
Silver Supply and Demand Balance - 17th Nov 21
Sentiment Speaks: This Stock Market Makes Absolutely No Sense - 17th Nov 21
Biden Spending to Build Back Stagflation - 17th Nov 21
Meshing Cryptocurrency Wealth Generation With Global Fiat Money Demise - 17th Nov 21
Dow Stock Market Trend Forecast Into Mid 2022 - 16th Nov 21
Stock Market Minor Cycle Correcting - 16th Nov 21
The INFLATION MEGA-TREND - Ripples of Deflation on an Ocean of Inflation! - 16th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Real Secret to Warren Buffett's Investing Success...

InvestorEducation / Learning to Invest Mar 12, 2015 - 07:36 AM GMT

By: DailyWealth

InvestorEducation

Porter Stansberry writes: Fair warning, gentle reader... the next two DailyWealth essays are, in all likelihood, a waste of your time.

Unless, that is, you'd like to know the real secret to Warren Buffett's almost unbelievable investment track record over the last 50 years. In my view, understanding this secret is bar none the most valuable thing you can ever learn as a common-stock investor.

 
As some of you may know, I'm currently writing a book about Buffett, titled Warren's Mistakes. I know... the world doesn't need another book about Buffett. There are dozens of good books out already. (The two best are The Snowball by Alice Schroeder and Buffett: The Making of an American Capitalist by Roger Lowenstein.)
 
I'm writing my book because the mainstream media and most of the financial community fail to realize how much Buffett's investment style has changed since 2000. And not for the better, either.
 
In the next two essays, I'd like to show you what lies at the center of Buffett's incredible results... and exactly why his more recent results have been lackluster.
 
AQR Capital Management is one of the world's largest and best quantitative hedge funds. Its founder, Cliff Asness, got a PhD at the University of Chicago. He studied alongside the "market is perfectly efficient" crowd... the guys who think it's impossible to beat the market consistently. But when he studied the market carefully, he found patterns – thousands of anomalies – that could be exploited for profits.
 
If you read Steve Sjuggerud's work, you'll recognize the strategy that Asness discovered. He found that both value strategies (buying stocks when they are significantly underpriced relative to their assets or earnings) and momentum strategies (buying stocks that are going up or selling stocks that are going down) worked.
 
But the best strategy was combining the two approaches, buying cheap stocks after they began to go up. Or, as Steve puts it, Asness found that buying stocks that were "cheap, hated, and in uptrend" was the best way to beat the market.
 
While Asness wasn't the first market analyst to adopt this approach, he was the first researcher who took the time to assemble enough high-quality data to prove it worked empirically. By the mid-2000s, Asness was managing almost $40 billion in capital, utilizing various computerized strategies that distributed investments among hundreds of stocks that met his criteria. (Likewise, Sjuggerud has also built computer systems to aid his investing. His True Wealth Systems track record outperforms his own human-selected recommendations in True Wealth.)
 
I bring up Asness because you need to understand there's probably nobody in the world more qualified to pass judgment on Buffett's track record.
 
Asness has been the world's leading market empiricist since the early 1990s, when he built investment bank Goldman Sachs' first quantitative investment fund before founding AQR in 1997. Asness is a genius at studying how the market actually works, instead of simply describing how it ought to work.
 
In 2013, Asness sponsored a "deep dive" into understanding how Buffett was able to produce such outstanding results over such a long period of time.
They looked at all the stocks and mutual funds that have traded since 1926 and found that nothing beat Berkshire Hathaway. That is, Berkshire has the highest "Sharpe ratio" among all possible publicly traded equity investments.
 
For those of you who aren't finance geeks, the Sharpe ratio is a simple measure of a stock's annual return over its volatility. Put simply, Buffett has earned roughly twice the returns he should have been able to make given the volatility of Berkshire's stock.
 
While that's incredibly impressive – the best record in the entire stock market – it's still not enough. Doubling the return of the stock market only gets you to about 16% annualized returns... not the 20% annualized Buffett has earned at Berkshire. So how did he do it?
 
The real secret Asness discovered is leverage. What? How is that possible? Berkshire is rightly famous for being a fortress of financial stability. The company currently holds around $250 billion in cash. It has no net debt. Over the long term, the company has averaged total debt (short- and long-term) of around 20% of book value.
 
Nevertheless, Asness' team reports, "We estimate that Buffett applies a leverage of about 1.6-to-1, boosting both his risk and excess return in that proportion."
 
This leverage was created by using the "float" from his insurance companies. That's the money that was paid in insurance premiums but not yet paid out in claims. Berkshire currently holds $84 billion in float. Berkshire's insurance subsidiaries have a 12-year record of profitable underwriting, so Buffett has used all of this capital for free. It's this leverage that explains the rest of Berkshire's "alpha" – of the excess returns Buffett has earned.
 
Buffett isn't the only investor who figured out that leveraging safe stocks can produce outstanding results. In the 1940s, while serving as an insurance regulator for the state of New York, Shelby Davis figured out that some insurance companies could compound their book value at market-beating rates. These rare firms, with exceptional underwriting skills, proved that they could increase their net worth, year after year, regardless of the economy.
 
In 1947, Davis quit his job. Starting with just $25,000, he set to work as a private investor, exclusively buying high-quality insurance stocks. Within 15 years, he was a millionaire. At his death in 1994, he was worth nearly $1 billion. His average annualized gain was 24% – matching Buffett's. Davis produced this result without the benefit of controlling an insurance company. He was merely an investor in the common stock. But he used full margin at all times. This greatly amplified his returns and greatly increased the volatility of his portfolio. It nearly wiped him out in the 1974 bear market.
 
The Asness team saw the same kind of volatility in Berkshire's shares. Berkshire fell 51% from peak to trough in the 2008-2009 financial crisis. It saw a 49% decline in the bear market of 2000. It fell 37% during the "Black Monday" stock meltdown in 1987. So the Asness researchers asked the key question: What kind of stocks are good enough and safe enough to be leveraged successfully over long periods?
 
What they discovered won't surprise you. Here's how they described Buffett's picks: "He buys stocks that are safe, cheap, and high-quality (meaning stocks that profitable, stable, growing, and with high payout ratios)." Pay special attention to the last criterion (high payout ratios). We'll come back to this attribute in tomorrow's essay... By using this description, the Asness team is withholding something critical.
 
Using this information, the Asness researchers programmed their computers to run simulations "buying" large numbers of companies that matched Buffett's criteria. By doing this, they were able to build portfolios that were highly correlated to Buffett's portfolio. Using leverage on these portfolios, they were able to produce results that matched Buffett's, even though their portfolios were far more diversified and made up of different stocks. As the Asness team concluded...
 
We find that the secret to Buffett's success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails. Indeed, we find that stocks with the characteristics favored by Buffett have done well in general, that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a low financing rate, and that leveraging safe stocks can largely explain Buffett's performance.

In tomorrow's essay, I'll explain the key to finding companies that are good enough and safe enough to leverage like Buffett has. I'll also show you how Buffett's strategy has drastically changed since around 2000... and why these fundamental changes have doomed Buffett, and Berkshire Hathaway, to underperformance in the years ahead.
 
Regards,
 
Porter Stansberry

Editor's note: If you'd like more insight and actionable advice from Porter Stansberry, consider a free subscription to DailyWealth. Sign up for DailyWealth here and receive a report on how to prosper despite the Fed's inflationary policies. This report will show you how to protect your hard-earned money from what Porter has dubbed the "End of America." Click here to learn more.

http://www.dailywealth.com

The DailyWealth Investment Philosophy: In a nutshell, my investment philosophy is this: Buy things of extraordinary value at a time when nobody else wants them. Then sell when people are willing to pay any price. You see, at DailyWealth, we believe most investors take way too much risk. Our mission is to show you how to avoid risky investments, and how to avoid what the average investor is doing. I believe that you can make a lot of money – and do it safely – by simply doing the opposite of what is most popular.

Customer Service: 1-888-261-2693 – Copyright 2013 Stansberry & Associates Investment Research. All Rights Reserved. Protected by copyright laws of the United States and international treaties. This e-letter may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Stansberry & Associates Investment Research, LLC. 1217 Saint Paul Street, Baltimore MD 21202

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Daily Wealth Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in