Why You Should Always Watch, But Not Always Listen To, Warren Buffett

September 13, 2017

Why You Should Always Watch, But Not Always Listen To, Warren Buffett

  • There’s a difference between what Buffett says and what he does.
  • Perhaps he doesn’t do the dirty work, but he for sure has someone else do it for him.
  • I’ll discuss three famous quotes that can be seen from various perspectives.

Introduction

I often mention Warren Buffett and his valuable investing advice. However, not all that he says has to be blindly believed.

In this article, I’m going to debunk some of his most famous statements by showing that he neither follows his own advice nor do some of his theories still hold in the current environment.



#1 – Buy Businesses That An Idiot Can Run Because Sooner Or Later, One Will

This is something that’s appealing to all investors. We would all love to buy a stock and then just sit back, enjoy our lives, and see the investment grow unaffected by whatever is going on in the business environment or global economy.

If we look back in history, we can see that some of Buffett’s investments were actually simple businesses that almost anyone can run. His favorite example is always See’s Candy, a company that produces and retails boxed chocolates. Buffett bought the company in 1972 for $25 million and the company earned $1.9 billion in pre-tax earnings up to 2014 which makes it a simple and great investment.

However, even now, See’s Candy is just a small piece of the Berkshire puzzle and most of their holdings aren’t that simple to run and require geniuses at the helm. The perfect example is Berkshire’s insurance and reinsurance business where every letter to shareholders is full of praise for Ajit Jain, the head of the Berkshire Hathaway Reinsurance Group.  An excerpt from Buffett’s latest letter to shareholders helps explain what I mean.


Figure 1: Buffett’s on the reinsurance business. Source: Berkshire Hathaway.

Now, if you have someone that can insure risks that “no one else has the desire to take on,” I wouldn’t describe that as a simple business any idiot could run. Further, attributes like capacity, speed, decisiveness, and brains aren’t something idiots often possess.

Another example is Buffett’s last few food deals: Kraft-Heinz which worked, and Unilever which failed. In 2013, Buffett, in partnership with Jorge Paolo Lehman from 3G, acquired Heinz. In that deal, Buffett provided the capital and the public name while 3G, a private Brazilian equity firm, took control of the food giant.

What Lehman does when he gets a company is slash costs and cut staff in order to improve margins and profitability. He was extremely successful in doing so with Heinz and I assume that was the main reason Unilever’s management was against the takeover, they were afraid heads would roll. Lehman replaced 11 of the 12 company heads at Heinz while letting go of thousands of other employees. When asked about Lehman’s activity, Buffett simply responded that such behavior is a standard capitalist formula.

So most of Berkshire’s investments aren’t simple businesses any idiot could run. Buffett has adapted his views as we aren’t in the 1970 anymore and it’s practically impossible to find simple, great businesses at normal valuations. Therefore, the message is: find a good business with good management, but be ready to bail as soon as that changes.

#2 – First Investing Rule: Don’t Lose Money. Second Rule: See Rule Number One

This isn’t so much a lie as it is misunderstood by the general public. It’s impossible to invest and never lose money because many things can go wrong and markets are volatile. The important thing is to make profit in the long term and you make long term profits by focusing on increasing the book value of your investments, not by focusing on stock prices.

In the last 52 years, Berkshire’s book value increased only twice, in 2001 and 2008, while its stock price has had 11 years with negative returns, as did the S&P 500.


Figure 2: Berkshire’s book value, market price, and the S&P 500 yearly performance. Source: Berkshire Hathaway.

The problem is that many see those stock price movements as a loss, while Buffett and Munger don’t regard market moves as losses. That’s the big difference between what Buffett and Munger think and what is often perceived by the general investment community. The permanent capital loss in book value is something you should avoid at all costs, market volatility should be welcome. So don’t be afraid of volatility and short term negative returns, they don’t have to be a loss especially if you are confident in what you’ve bought.

#3 – Buffett Often States How He Doesn’t Care What The FED Does Or Will Do

This might have held true in the past as the FED merely lowered interest rates in a recession and raised them quickly when things improved. However, since 2009, things have changed and the FED is now an extremely important player in financial markets.

Before 2009, the FED’s balance sheet was minimal and stable but after 2009, the correlation with the stock market can’t be considered a coincidence as the increased liquidity pushed asset prices higher.


Figure 3: FED’s assets and the S&P 500. Source: FRED.

So, is Buffett still uninterested in what the FED is doing? He might still be saying he is, but the pile of cash he has accumulated over the last few years shows that he is waiting for higher interest rates to push asset prices higher. Higher interest rates are bound to happen sooner or later, influenced by either inflation or improved economic activity.


Figure 4: Berkshire’s cash pile has reached $100 billion. Source: Bloomberg.

As Buffett has never held so much cash, it’s clear that he is also watching what’s going on with interest rates.



Learn From Buffett, But More From What He Does Than From What He Says

To conclude, I must say, I’m still a Buffett fan but I won’t take all of what he says as gospel. If you read Buffett’s biography, you can see that his first intention is to be liked by people which leads to saying things that aren’t offensive and that people want to hear. If you want to hear the truth, then you should listen to Charlie Munger. Munger doesn’t care what people think of him and certainly doesn’t care how you feel about what he says.

To conclude on Buffett and Munger, I’ll soon write an article on Charlie Munger as there is perhaps even more to learn from him than from Buffett, so keep reading Investiv Daily.