This is a topic I’ve wanted to write about for a while. Those stock pickers who decide not to migrate to the camp of chartists, tee leaf readers or other witchcrafts, will likely join the group of value investors. In this context, the name of Warren Buffett must not miss. Many investors claim to emulate his strategy, others try to seek inspiration which stocks to buy. Today, I will show that both are delusions.
Summary and key takeaways from today’s Weekly
– Copying Buffett is almost impossible and close to nobody will use the same strategy that Buffett uses, namely very high portfolio concentration due to conviction, but also size limitations.
– Also, one should always be careful with headlines about what Berkshire or Buffett is said to have bought or sold – look under the hood.
– All in all, for a private investor, it is rather not interesting to spend too much time on following what Berkshire does, as it is not comparable to one’s personal setup.
I want to start this article straight to the point and maybe even a bit provocatively:
Even if they deeply believe in it, the majority is NOT adopting Buffett’s investment style and the majority should not try to copy his stock picks.
Don’t they say otherwise? Isn’t his performance the only proof you need?
Long-term “buy and hold” and only buying old-school, easy to understand businesses at valuations below the intrinsic or true value of the underlying business?
What about all the great books that describe what wonderful picks he had with
- Apple (ISIN: US0378331005, Ticker: AAPL)
- American Express (ISIN: US0258161092, Ticker: AXP)
- or – this is the most often mentioned, but also misunderstood one – Coca-Cola (ISIN: US1912161007, Ticker: KO) where he has a personal yield on cost of more than 50% (dividend in relation to his average purchase price)?
Not so fast, because if one’s honest, the majority of retail and do-it-yourself investors cannot and will never do exactly what Buffett does. And they shouldn’t.
There are good reason why this is the case.
The funny thing is, Buffett himself said he wouldn’t do it either, weren’t Berkshire such a gigantic tanker, barely able to maneuver.
Six weeks after the end of a quarter, when Berkshire Hathaway (ISIN: US0846701086, Ticker:BRK.A) must file its portfolio activity with the SEC, many (millions of) investors are excited to have a look into the publication, trying to draw conclusions from it.
I argue that this is wasted time.
It absolutely makes no sense to try to emulate what happens inside of Berkshire. There are several points you should understand and seriously think about.
This is rather a much different article than I have written in the past. I am seeing many people on YouTube and Twitter / X not only discussing Berkshire’s transactions, but also publicly speaking and writing about their Coca-Cola shares and “other typical Buffett stocks”, because Buffett owns them, incentivizing them to own them, too. And – I fear – without understanding the context properly.
Today, I am going to uncover why it’s better to put this into the noise bucket.
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What you should know before copying Buffett
It all starts already with the structure of Berkshire compared to I guess almost everyone’s private portfolio.
Berkshire is a conglomerate that consists of:
- an insurance business (well, not only one)
- privately / fully owned companies like Precision Castparts (aircraft supplier), See’s Candies (you know), GEICO (car insurance), General Re (reinsurance) or BNSF (the railroad Berkshire fully owns)
- a block of railroad, energy and utilities (with big overlaps to the point above)
- a huge cash pile, respectively short-term US government bond holdings
- equities, i.e. what many people look at
While not only no one of us will have a similar setup to manage, it would be foolish to look just at what happens in the equity bucket, either.
It is known that Buffett is a huge fan of well-managed insurance businesses due to them throwing of excess cash – the famous “float” or interest free money – which can be invested, assuming the business pays less for outstanding claims than it collects in insurance premia. We also have the private businesses contributing strong cash flows.
This is the first issue, as there are interconnections.
The second is that Berkshire has a balance sheet of slightly above 1 tn. USD or about a third of Apple’s market cap (but 3x the assets / balance sheet Apple has), just for comparison.
Of this, cash and bonds are about 18%, the railroad, energy and utilities block is valued at around 25% of all assets and the stock portfolio at 30-something percent, let’s say a third for simplicity. The rest are other assets a private investor usually does not have.
So, Berkshire is by no means just an equity fund “with some excess cash”.
What is often said and written about Berkshire and Buffett is that their gigantic liquidity reserve (cash and short-term debt) of 150 bn. USD must be a sign of Buffett being bearish and expecting a crash and / or not finding any value, because everything is said to be overvalued.
To the contrary, it is well known that Buffett numerous times said not to bet against America and that he is fully convinced of the power of the American economy.
He also never participated in any market predictions and fear mongering. So why should he hold cash artificially, waiting for a correction?
To be honest and direct, it is absolute garbage and amateurish to think so.
And by the way, when there was a gigantic opportunity, namely during the meltdown of 2020 which not only brought lower stock prices, but above average trading volume (see below why this is important), Berkshire, respectively Buffett did not make use of it. Also, when oil stocks got hammered a few months later in the context of negative oil prices for a day – no, he didn’t load up aggressively.
Even though it is debatable whether America will stay the superpower of world, we can rule out any market timing actions by Buffett.
The real reason for this cash pile – and btw, percentage-wise Berkshire had in the past similar liquidity holdings as Buffett will never be fully invested – is the size of Berkshire, respectively the available targets.
Berkshire is simply too big and the opportunities are too small in size.
As Buffett is known to be rather tech-averse and, unfortunately for him, tech stocks being the biggest enterprises, the investment universe is pretty small.
Any wonder why he is forced to go “elephant hunting”, i.e. buying whole companies which at the right price and at an adequate scale are tough to find, because a private buyer must want to sell?
Sure, Berkshire could pay dividends – Buffett is not a fan of it, so we should better not expect any. He’s doing occasionally some buybacks of the equivalent of about 2% p.a. compared to the market cap, as they’re tax advantageous. But at a market cap of almost 800 bn. USD, 2% are already 15–16 bn. USD p.a. which is not nothing.
This has some limitations, as Buffett certainly does not want to pay too much.
However, at a price to book ratio of 1.5x, he likely won’t feel too greedy as his former limit was 1.2x or below. I don’t know how it stands today, as I am no uber-Buffett-fan.
This leads us to the remaining options, buying more bonds – this is not what Buffett fans aim for, despite throwing off some interest income again – or buying stocks.
As I wrote above, Berkshire’s size is the problem.
While one could argue that he can easily buy a stake in a company like Exxon (ISIN: US30231G1022, Ticker: XOM) to quickly bring his cash to work, this does not represent the reality. The context and what is doable in practice, are entirely different. A quick back the envelope calculation to show you why even buying enough shares of such a huge company like Exxon is no walk in the park for Buffett:
Exxon has a market cap of give or take 410 bn. USD. It is currently the 15th biggest US company as of writing (see here) and one of the ten biggest non-techs.
While the uninformed might think that this is easy going – it isn’t.
Exxon’s trading volume is about 2–2.5 bn. USD (not stocks, US-Dollars or about 20 mn. stocks) per day. As no one can buy all stocks in one day and of course to avoid pushing the price up, realistically 10% to at best 20% of what’s changing hands can be acquired or in hard numbers 200–500 mn. USD daily.
To invest 10 bn. USD in Exxon, it would take at the minimum 20 trading days under almost optimal circumstances. More realistically, it would need 40–50 days or almost a full quarter. And this assumes that no one will notice and jump in.
Also, keep in mind that Exxon is repurchasing its own shares, effectively competing as a buyer in this thought-experiment.
So, almost a full quarter to invest 10 bn. USD in one of the biggest companies on earth shows you the problem Berkshire has.
10 bn. USD is less than 7% of the whole liquidity pool.
But we can also think the other way around – it would take almost a quarter for Berkshire to get out of the stock. This is comparable to us investing in highly illiquid stocks. The same as the stock price would likely go up while Berkshire buys, it would likely also fall when the stock is sold – not an easy situation to be in!
This way, you can be sure that the needed conviction to buy (and practically be forced to hold) a stock of any meaningful scale, must be pretty high.
Speaking of selling, this is another topic many seem to not understand.
If you understood the above, you will also maybe question some of Buffett’s holdings in the sense of whether they’re of interest for a small private investor. We can safely say that the only liquid stock, measured by Berkshire’s size, is Apple.
Selling everything else would certainly massively influence stock prices.
Here’s what I think about Coca-Cola: Buffett waited long during the entire 1980’s, then started to buy shares of KO in 1988, even after the 1987 crash, and over a period of five or six years. Since 1993 or so, however, not a single share was added!
Buffett still holds the known 400 mn. stocks he once acquired. He cannot get out of them anymore. The stock likely would crater, as many evangelists would start running out through the same door.
You should also keep in mind that Buffett back then bought a growth stock at a considerable PE ratio of 15–16x (I don’t like the PE ratio, but used here for simplicity reasons). At the same time, earnings per share were up by +17.3% in 1988. Net income grew by 14% and 3% came from buybacks, see below the 1988 annual report.
Peter Lynch’s PEG ratio (PE to growth) was below 1. Today, it’s several times that. And yet people claim to be as clever as Buffett by buying Coca-Cola stocks today.
The other thing is taxes: as Buffett is up about 20x or so on unrealized capital gains, he would need to pay billions in taxes. As he does not like to pay taxes and many times argued to keep on holding a position to avoid taxes, he certainly prefers to collect his rather safe 736 mn. USD and growing in yearly dividends which is a nice supplementary income for doing nothing.
Many people celebrate Buffett’s yield on cost of now even more than 50%, as the 1.84 USD of the yearly payout is more than 50% of his average purchase price that was somewhere in the low 3’s USD.
This is a metric that I already criticized as being useless.
While it sounds nice that he gets a more than 50% “personal” dividend yield, he could receive exactly the same total USD amount by switching to a new investment yielding c. 3.5%, even after capital gains taxes.
The reason is that in Coca-Cola only his initial stake is working, i.e. qualifying for dividends. With a new investment – if he found any where he could get in easily – the whole capital block could be put to work.
But he cannot get out of this position – by the way Coca-Cola’s average daily trading volume is only a good billion in USD, so that he would need about 12 months to get out (24 bn. USD / 100 mn. USD daily * 20 days per month)*, assuming optimal conditions.
*The market value of Berkshire’s KO holding is currently 24 bn. USD. I used 10% of daily trading volume for this calculation, as Coca-Cola is also frequent buyer of its own stock.
You can be sure that if there were news that Buffett reduced his stake from 9% to 5% that the stock would drop.
Next point to have a look at: stock portfolio composition.
While it seems to be set in stone to use the name of Buffett in the same context of stock picking as well as having a broadly diversified portfolio, this is nuts.
Buffett is a fan of highly concentrated, not diversified portfolios.
He is famous for having said things like that a professional should know what he’s doing, so there is practically no reason to be over-diversified. In the same context, why should anyone put money in his 20th best idea, when there are 19 better ones and especially the top three or five? Why neglect them?
Then you see “Buffett fans” having portfolios with 50 stocks and micro-weightings.
And this is how Buffett operated and still is, however.
Please show me a true Buffett fan who has 50% of his stock portfolio in one stock. Or almost 60% in his two best ideas. Maybe it gets easier to find 75% in the top four?
The truth is rather that most people are afraid to even buy a starting position of 10% of their portfolio and to hold 20% in their best stock. This way, I highly doubt that so many people are copying Buffett’s investing style.
Buffett is diversified – however, only over asset classes. Else, he is highly focussed.
There are also some minor topics, which I do not want to over-discuss.
First, not all trades are from him personally. It is well known that his two right hands Greg Abel and Ajit Jain have own rooms to operate and invest.
Second, when yo hear that Buffett or Berkshire bought a new stake in a company, first check how big the size is. If it is not even 1% of the portfolio, it is no sensation.
Third, there is a huge time lag. The filings are around six weeks after a quarter’s end. So, what is published can be already outdated or in the worst case sold again.
Forth, Buffett and / or his deputies, do not just long-term buy and hold.
Just have a look here:
Fifth, when you hear that “Buffett has sold a position”, better keep in mind that it does not have to have been him and that it could have been required for regulatory / strategic purposes. Buffett only holds more than 10% of outstanding equity in American Express as well as Occidental Petroleum (ISIN: US6745991058, Ticker: OXY).
The reason is, above the 10% threshold come stricter reporting obligations. Just look at the almost weekly news that Berkshire increased its stake in OXY which now reached 34% (see here).
This way, when some pieces of the close to 10% holdings like Coca-Cola or Bank of America (ISIN: US0605051046, Ticker. BAC) get sold, it is likely not due to Buffett having lost faith, but cosmetics to stay below the 10% threshold as many of his holdings are repurchasing shares and upping his stakes frequently without him getting active personally.
You see, why it is more than just “buying Buffett stocks like Coca-Cola”.
We as small investors have many advantages and less limitations. For example, in my latest research report for my members, I wrote about “changing horses” to a company that won a legal case and is now likely to enjoy huge tailwinds and growth for years to come – no matter what the economy does. Even if Buffett bought the whole company, it would not move the needle for him.
Copying Buffett is almost impossible and close to nobody will use the same strategy that Buffett uses, namely very high portfolio concentration due to conviction, but also size limitations.
Also, one should always be careful with headlines about what Berkshire or Buffett is said to have bought or sold – look under the hood.
All in all, for a private investor, it is rather not interesting to spend too much time on following what Berkshire does, as it is not comparable to one’s personal setup.
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