Warren Buffett's True Investment Strategy

This post was written by Tony Chou, who runs the Investorz’ Blog, a blog about investing and the financial markets.

Prepare to be shocked (or at least I hope to shock you). This is Warren Buffett’s investment strategy.

I hate to break this to you, but Warren Buffett has been lying to the public for years, all the while putting on a straight face. This is how Warren Buffett describes his investment strategy.

Warren Buffett is a value investor. Value investors look for securities with prices that are unjustifiably low based on their intrinsic worth. When discussing stocks, determining intrinsic value can be a bit tricky as there is no universally accepted way to obtain this figure. Most often intrinsic worth is estimated by analysing a company’s fundamentals. Like bargain hunters, value investors seek products that are beneficial and of high quality but under priced. In other words, the value investor searches for stocks that he or she believes are undervalued by the market. Like the bargain hunter, the value investor tries to find those items that are valuable but not recognised as such by the majority of other buyers.

Warren Buffett takes this value investing approach to another level. Many value investors aren’t supporters of the efficient market hypothesis, but they do trust that the market will eventually start to favour those quality stocks that were, for a time, undervalued. Buffett, however, doesn’t think in these terms. He isn’t concerned with the supply and demand intricacies of the stock market. In fact, he’s not really concerned with the activities of the stock market at all. This is the implication this paraphrase of his famous quote : “In the short term the market is a popularity contest; in the long term it is a weighing machine.”

For the longest of time, I was fooled by Warren (I was so stupid). Now, it’s clear that this is a big fat lie. Here’s a quote from an article in The Economic Times.

NEW YORK: Goldman Sachs Group won the backing of Warren Buffett, the world’s pre-eminent stock picker, as the Wall Street firm seeks to raise cash from investors whose faith in the investment-banking business model has been shaken.The bank soared 11% to $138.17 in German trading on Wednesday.

For Goldman, the endorsement came at a price. Berkshire Hathaway, led by the 78-year-old billionaire, is buying $5 billion of perpetual preferred stock with a 10% dividend. Berkshire also gets warrants to buy $5 billion of common stock at $115 a share at any time in the next five years. The common stock closed on Tuesday at $125.05, providing Buffett with an instant paper profit of $437 million.

“It’s a hell of a deal for Buffett,” said Brad Hintz, an analyst at Sanford C Bernstein who rates Goldman stock “market perform”. “The key thing for Goldman is making it through the credit cycle, and they’re doing the right stuff,” Hintz said.

In case you didn’t know, Goldman Sachs later fell to a low of $53.31 per share. So my arse Warren Buffett bought Goldman Sachs because it was undervalued. You want to know why Buffett bought GS? Because he had inside information. That’s right. The Buffett you all thought was a “value investor” isn’t. Here’s his real investment strategy.

  1. Get insider tips, and maintain a low profile from the Fed.
  2. Buy cash generating companies.
  3. Time is on your side.

1. If you ask Michael Steinhardt, he’ll tell you that Warren is a con. He actually depends on insider information. Take the Goldman quote I mentioned above. How did Warren know that the Fed was going to bail out GS (after all, they didn’t bailout Lehman). Even an idiot would know that Warren Buffett had insider information (probably from the Fed).

2. Also, Warren isn’t truly an investor. What Warren Buffett really likes to do is to buy entire companies. Investors like Jim Rogers and George Soros buy stocks because they like it’s prospects. Even in his own biography Warren mentioned that his preferred holding time is “forever”, and he likes to buy entire companies. Warren especially likes insurance. The cash flows his insurance companies generate are used for investments. Warren’s ideal kind of company are the ones who can be run by a “ham sandwich” and generate large amounts of cash flow. Meanwhile, he’s preaching “value investing.” Trust me, unless you have billions of dollars to snap up companies with and lots of connections with the big guys in the government and executive boards, don’t pay attention to what Warren Buffett does. You can’t copy his strategy.

3. Warren Buffett has the ability to wait out a crisis. This investment strategy is very hard to copy. Warren can afford to watch a stock he bought drop from $115 to $50, and then back up to $180. Why? Because he owns a lot of cash generating companies. Hedge funds can’t use this strategy. They have quarterly redemptions, and investors would withdraw their money if they saw that a stock the hedge fund owned dropped from $115 to $50. The small, full time investor who’s entire portfolio is only worth $400,000 can’t afford to just wait the crisis out. He’s got a family to feed.

Warren is no true value investor.

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