Replicating Buffett

I've often wondered why Warren Buffett's formula for building wealth is so hard to replicate.  I think a few things are at play that prevent the average investor from obtaining the sorts of returns Buffett has throughout his career:

Fear of uncertain outcomes
A misunderstanding of Buffett's entire approach
The wrong mindset and temperament

Fear of uncertain outcomes:  Even though Buffett's approach to investing is tried and true, it's not certain that someone, following Buffett's approach to a tee, will have the same results.  What if they enter the market right before a recession or crash and lose a large chunk of their net worth?  Buffett has the confidence from years of experience on his side and he obviously has the means to wait out a dip in the market.  In fact, these days, he looks forward to a dip.  His Berkshire Hathaway has so much cash on hand right now that he'd love to put some of it to work in the market but equities have recently been out of his buying range.  The hard part is waiting until the opportune time to place your bets.  And even then, with a rather concentrated portfolio of your best picks, your portfolio will likely be much more volatile than Dow Jones or an index fund.  Many people don't fare well with this sort of uncertainty.

This potential lack of a security net scares many potential investors off, as well, as they have families to take care of and other needs to be met.  Society also tends to frown upon the guy who leaves a secure, high paying job, to pursue wealth in another venture.  It appears irresponsible or greedy or lazy.  However, those who do make the jump and do it properly tend to be rewarded.  Read Charlie Munger's bio; he left a great career in law to pursue investing full time. 

Taking the first step is also difficult.  How do you know when to enter the market?  This, I believe, can't be learned from the sidelines, but must be obtained from experience.  But taking the first step in anything is difficult.  We often don't embrace change, but change is necessary.

A misunderstanding of Buffett's entire approach:  Many hear Buffett's name and think, "stock market genius".  In reality, Buffett has many more layers than his stock picking prowess.  He prefers to buy entire private businesses rather than parts of large companies via public trading.  He also suggests avoiding excessive debt, but if you understand his approach, he uses significant amounts of borrowed money (insurance "float") to invest in other businesses.  His debt is cheap or possibly free; "float" is the money his insurance companies collect as premiums that he can invest until a claim is placed and some money must be paid out to settle the claim.  Therefore, if his insurance underwriting team writes profitable policies, the premiums he collects less the administrative expenses becomes additional profit that he can invest.  He's basically being paid to borrow money!  It's brilliant!

While Buffett's stock market record is absolutely incredible, he never would have been able to take advantage of Mr. Market to the extent that he has, had he not bought privately held businesses that kick off significant cash and provide investable income via insurance float.  This is why I believe there is only one Warren Buffett.  Buying a business is daunting.  I know that from experience.  And it takes a number of years for many businesses to reach their full potential or even turn a profit.  This is such an important, yet under appreciated, aspect of Buffett's approach.  I would venture to say that those who study Buffett's philosophy and follow his advice, rarely buy businesses.  They are missing a key ingredient in duplicating Buffett's success.  Others have had success in the market like Buffett.  Read his, "The Superinvestors of Graham and Doddsville" article for evidence.  But the magnitude of his accomplishments was made possible by the cash kicked off from his private businesses.

The wrong mindset and temperament:  Buffett also ENJOYS the extreme long game, not because he has to, but it's simply his mindset.  He wants to be able to sleep at night stress free; a portfolio manager doesn't have that luxury.  Professional money managers can't touch Buffett because they need to keep up, year after year, with their colleagues and competitors.  A portfolio manager can't tell his boss to give him 5 years before reviewing his performance.  Buffett never had to answer to anyone but himself and his partners - and his partners had full faith in him. 

Individual investors are in the same boat.  They can't handle the ups and downs of the market and so they end up selling out at the wrong time.  They don't focus on the long game.  They don't have the confidence that things will work out.

Buffett is truly one of a kind and the goal doesn't need to be to attain greater wealth than him.  If one can accomplish a tenth of what he has accomplished, they will find themselves very well off.  To do that, you need to be comfortable with the uncertainty, understand the Oracle's entire approach, and keep a level head with a proper mindset.

Like Diamonds, Cycles are Forever - Premature Thoughts on a Stock Market Crash

It is a bit early to call this past week's action a "crash" or to state that the market is in the midst of a crash, but it is also always wise to plan ahead for various possible future scenarios.  From a value investor's standpoint, crash = opportunity.  The last few years since the 2009 financial crisis, may have been a bit rough for value investors.  While the rising tide of the market over the last 6 years has inevitably raised all boats, those who focus solely on a Graham-esque value strategy may have been left in the dust as growth stocks have been the been doing the heavy lifting.

Bull runs of this nature are difficult for a value investor to stomach.  He likely invested in the 2009 crash, enjoyed the gains until he sold out at what seemed a fair valuation, and subsequently watched agitatingly while the overall market continued to appreciate.  He has likely either converted to mostly cash or focused on commodities, energy, and possibly retail stocks, which have lagged behind the rest of the market sporting low P/E's and P/B's.  Energy and commodities, specifically, have been absolutely hammered this year, while the Dow finally appears to be leveling off after the 5 year bull run.  He follows all of the rules he has picked up from Graham, Buffett, and gang, yet it appears those around him blindly throwing money at in-vogue stocks like Tesla are the ones celebrating!  He has flashbacks to 1999-2001.

But bull markets must come to an end and, like diamonds, cycles are forever.  Love him or hate him (I, for one, am not a big fan), Jim Cramer makes some valid points in "Real Money" when it comes to cycles.

Lessons of an Investing Addict Part 2: Book Value Strategies

“I’m not very good at judging people. So I found that it was much better to look at the figures rather than people. I didn’t go to many meetings unless they were relatively nearby. I like the idea of company-paid dividends, because I think it makes management a little more aware of stockholders, but we didn’t really talk about it, because we were small. I think if you were big, if you were a Fidelity, you wanted to go out and talk to management. They’d listen to you. I think it’s really easier to use numbers when you’re small.” -- Walter Schloss

In Part 1 of this series, I talked in generalities about laying the groundwork for becoming a successful investor.  I discussed some good literature to get you started down the right path and suggested familiarizing yourself with economic cycles.  Finally, you should choose whether you identify yourself as a speculator, a trader, or an investor and then to get your feet wet by putting a minimal amount of funds into a discount brokerage to get a "feel" for the market.

I have spent years researching different methods of equity investing and learned some expensive, but valuable lessons along the way.  My ego has led me to believe I could trade stocks and beat the market; convincing me that somehow I had the gift to outdo the money managers who live and breath this stuff all day, every day.  I have since moved on from the guessing game and built an investment strategy around the techniques of Graham, Buffett, and my favorite, Walter Schloss. 

If you have any doubts about the effectiveness of a long-term value-investing approach, I highly encourage you to read "The Superinvestors of Graham-and-Doddsville", a speech by Buffett to a class at Columbia.  Buffett does a fantastic job articulating the school of thought that these "Superinvestors" adhere to while dispelling the argument that randomness is solely responsible for an investor's success.