What's Buffett's Ideology?

In this post, I am trying to take a contrarian viewpoint, and hopefully initiate a debate. I am asking few questions:

• Is Buffett ideology more than mere value investing?
• Are we individual investors falling into the value trap?
• Do we individual investors fail to realize or fail to put Buffett’s ideology in proper context?

First: Value investing is all about attempting to estimate value of a given business, and hence the stock price. Most of you will agree that estimating value is a very subjective process. With the same set of upfront information, seasoned professionals and many of us will come up with different value for the same business. If value investing was that simple and easy to determine, won’t all value investor have excellent portfolios? So does value investing also comes with gut feeling about future business prospects? What about asset allocation and diversification? When I looked into BRK’s portfolio in 3Q2008, it did not seem to follow any boiler plate formula or general guidelines of asset allocation or diversification. Does it mean Buffett’s ideology is more than mere value investing?

Second: Are we falling in the same trap as majority of us retail/individual investors? For a moment, let us ignore what other writer’s and commentators have written about Buffett. If we read Buffett’s own comments then we will note that he is an advocate of index investing. He has said many times that individual investors should not try to time the market or attempt to beat the professional. Checking his own verbatim in various interviews or column’s, we will find that he advises individuals to simply invest in low cost index fund and forget about it for next 10+ years. So is value investing only for professional with huge resource base?

Third: I agree that Buffett first thinks about business and management team. But we fail to realize that Buffett ideology has been built over the period of last 30 to 40 years. He has lived in an era of unprecedented growth in US economy. The growth in US economy was driven by baby boomers. I do not know what is in store for future, but it is likely that similar level of growth may not return again. Ever since 2000 the US economy has been floundering; I do not recall that Buffett has done anything worth a significant note within the realm of traditional US-based investing. In this era, until most recently, Buffett was holding on cash of more than USD 40 billion. Buffett’s huge winners came early this decade but in Brazil and China. Does that mean there have been no value based opportunities in US?

Fourth: On one side Buffett proclaims derivatives as weapons of mass destruction, while on other hand he himself has been dabbling in derivatives. Re-insuring already insured muni bonds! Collecting insurance premiums on stock indexes and bonds in the form of derivative contracts! Buffett’s stake in Credit Default Swaps and Currency Swaps! SEC asking BRK on how it values its derivatives! Are these examples of value investing within derivatives domain?

Fifth: In October 2008 Buffett proclaimed buy America, while at the same time during 4Q2008 and/or 1Q2009 BRK offloaded significant position of his holdings in landmark US companies. Buffett is using BRK’s cash to invest in instruments which are not available to general public. Remember his preferred share at fixed 10% interest rate both in Goldman Sachs and GE! So Buffett is taking advantage of huge cash and public stature to step on common shareholder dividends of less than 5%? Or does this mean there are no value investment opportunities even with markets down by more than 50%?

Don’t get me wrong, I admire Buffett, I like his value investing practice, I envy his business acumen, I am amazed by his humbleness, I love this simplicity, and I have lot of respect for him. There is nothing wrong in what Buffett is doing. He is doing what he is supposed to do. Make profits for BRK’s shareholders. And I must say he leaves no stone unturned to do that, even if it means moving away from his own teachings. Since he is not investing in common shares, does this mean there is no value in traditional US markets?

We need to put Buffett’s success in proper context. We need to realize that Buffett ideology has been built over last 30-40 years, which in itself was altogether a different era. Buffett’s ideology seems to be more than mere value investing. It is value investing accompanied with shrewd business acumen. Value opportunities can be anywhere; national, international, traditional stocks, bonds, derivates, currency, etc. You need business acumen to identify them and follow your value guts.

What do your little grey cells tell you? I would like to know so leave your thoughts in comments section below.

Full disclosure: Long GE.

Comments

[PSimon:]

You should read The Snowball. It will answer a lot of the questions you have. The GS and GE investments is just what he did for Salomon many years ago. He likes the 10% minimum yield while there is upside if the stock price goes up. The only way he loses is if the company files for bankruptcy. He is NOT changing his method, he still investing in companies that have economic moats that are under temporary stress. It is a mix of Ben Graham's value investing and Munger's idea of a business with significant and durable competitive advantages.

On the options, read his 2008 annual report. You will see that the European style options are just another way to invest using other people's money with low financing costs.

Apr 15 08:21 PM

[Ankit Gupta:]

I agree entirely with you Simon.

My question - GE clearly has many competitive advantages and wide economic moats, but my confusion, comes from their financial divisions, how do you analyze something like that?

Apr 15 09:35 PM

[THofler:]

I agree with PSimon also. I'm half way thru The Snowball.

Lots of comments come to mind, but to keep it shorter, I'm reminded of a Buffett quote and lengthy story in The Snowball.

"I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out."

In the 1980's American Express found itself legally liable for $100's of millions in losses in a soybean oil fraud prepetrated an independent commodity speculator. The stock tanked. An ordinary investor may have bought a 5 or 10% position near the bottom.

Buffett sent out a couple researchers who did detailed data collection on the number of AXP traveler's check transactions and credit card transactions, which were AXP's primary business. Only when the data proved that AXP's primary clients couldn't care less about the fraud problem, did he invest. And then he invested something like half of his entire fund in AXP.

Part of what made Buffett great was that he wants to be very sure (drain the water out first) and then he will fire a bazooka, not a pop gun.

Apr 15 11:19 PM

[Ricard:]

Before I comment, I'd like to know exactly who is writing an article that, on this website, appeared as if Buffett himself was writing.

First: This is obviously Buffett's prized trade secret. I'm sure Buffett has certain criteria he uses for value, but to divulge them while still alive would be to give someone else the opportunity to call the shots.

Second: Whoever this is masquerading as Buffett has not even taken the time to read his mentor's textbooks - Intelligent Investor and Security Analysis. Ben Graham is pretty clear to draw a line separating 'defensive' and 'enterprising' investors. When Buffett advocates index funds to the masses, he is assuming that most people do not have the time to be 'enterprising', i.e., pursue investment selections as a full-time occupation. These people should seek safety in diversification, and shy away from any activity that may resemble stock-picking.

So to answer your question - no, value investing is for those who have enough time to be 'enterprising'. You can have wads of cash and still not have the time to sniff out the deals, so such people also should probably stick to index funds as well.

Third: Buffett has repeatedly rung the bell predicting lower returns overall for the market. For Buffett to achieve his average 20% yoy returns, he'll have to do a lot better than the 5-7% he foresaw for the past ten years in the US. This was probably due to the extraordinary bull market you mention that coincided with Buffett's winning streak.

Fourth: Buffett's derivative exposure is completely dwarfed by even mid-size players in the derivative field. Add another 5 or 6 zeros behind his number, and you may begin to approach the massive exposure that Citigroup or AIG has on its books.

Fifth: Apparently Buffett thought that a 10% indefinite return was better than anything Johnson and Johnson could do. He likes a large cash base, so he was selling American to raise enough cash to buy American.



Lastly, to answer the three questions you posited in the beginning:

1) Of course. He also believes in Philip Fisher's growth-oriented model. But, I think for the most part, even in his derivative plays, he has remained very faithful to the value school.

2) Exactly what is your value trap? Do you think Buffett has fallen victim to it? I thought his GS preferred might have been a value trap. Time will tell, although it's seemingly becoming clearer that Buffett was spot on this one. Even his DOW 'debacle' is looking better and better.

3) That's for every individual to answer for themselves. But, anyone who hasn't thoroughly read Ben Graham's works will probably have to default to a 'no' answer to this one.

Apr 16 01:01 AM

[Ravi Nagarajan:]

"Before I comment, I'd like to know exactly who is writing an article that, on this website, appeared as if Buffett himself was writing."

I was wondering the same thing. This seems misleading to say the least. It is one thing to use an anonymous identity and another to use Buffett's name in this manner.

Apr 16 09:20 AM

[jrham:]

This is a gross misrepresentation of who the author is. Plagiarism?

Why not go right to the original source, "Security Analysis".

JR

Apr 16 09:26 AM

[TonyCinTX:]

Buffett's ideology is pretty simple; he invests in many things that he believes have a high probability of success. Over the decades, two things have happened.

First, although at core he remains a "value" investor, experience, losses, and successes which he had avoided have refined his ability to judge value, and see what is important. He summarizes this in every annual letter to shareholders.

Second, with wealth and backing, he has found new opportunities unavailable to him as a younger man, simply because a guy with billions can solve thorny problems which cannot be solved by a guy with a few million.

I don't understand this obsession with Buffett's "ideology." How many times must he elucidate it? He says he often knows within ten minutes whether he is interested in an investment or not. What can he possibly be looking at in ten minutes?

I will tell you: Who is buying the product and why? What are the margins? Where is the protection? Who is the competition? Why *this* company instead of them? What makes this company special, protected, or the most certain to succeed?

It isn't rocket science. If anything, I'd say the one thing Buffett has that other investors do not is self-discipline. Buffett can sit on forty billion dollars for a *year* without feeling compelled to *do* something with it. What Buffett has is the ability to wait, and wait, and wait, and still recognize and execute quickly when he sees an insanely low risk/reward ratio.

99.9% of investment managers are not willing to tell their clients, "We didn't see anything worth doing this year. Not one darn thing. So we sat on your money. Maybe next year!"

Buffett is so willing, and quite explicitly.

Apr 16 09:27 AM

[maxjones:]

I don't think that any human personality and the strategies and tactics it continually concocts and implements in response to continually changing external and internal signals, stimuli and environments (and in particular a complex personality such as Mr. Buffet's) can be reduced to a simple set of criteria, or principles or "how-to" guidelines. Sure, those can help others to understand more or less how someone thinks and acts. But they can't clone the person.

In the end every single decision made one way or another (by any one of us) is a unique decision made by a unique individual in a unique context and set of circumstances. So there are no simple recipes to follow to faithfully emulate anyone.

Moreover with respect to "ideology" more often than not those who create an ideology or tend to embody it, are also not necessarily capable of articulating it to others in a steady and stable and clear and understandable way.

So the best thing to do is to study a lot of people, a lot ideas and a lot of approaches and then try to come up with one that one can believe in and that seems to work for oneself in the given context. (which surely will change over time)

And I don't think Mr. Buffet would disagree with that.

Apr 16 11:51 AM

[Vox Rationalis:]

"Are these examples of value investing within derivatives domain?"

Yes!

"...during 4Q2008 and/or 1Q2009 BRK offloaded significant position of his holdings in landmark US companies. Buffett is using BRK’s cash to invest in instruments which are not available to general public. Remember his preferred share at fixed 10% interest rate both in Goldman Sachs and GE!"

These two are not unrelated. Buffett had an opportunity to exchange blue chip equity holdings with low dividends into blue chip equity holdings with high dividends. Who wouldn't do this?

"So Buffett is taking advantage of huge cash and public stature to step on common shareholder dividends of less than 5%?"

Wait, you're complaining about Buffett making such an investment? Do you think that every investment option should be available to every investor?

"Or does this mean there are no value investment opportunities even with markets down by more than 50%?"

If you think Buffett and/or BRK wasn't buying in early March, well, I think you're foolish.

"Since he is not investing in common shares, does this mean there is no value in traditional US markets?"

1. You don't know what he is investing in personally, nor do you have any better knowledge about what BRK's been doing than the rest of us.

2. Near the November bottom he was putting large amounts of cash to work in GS and GE. Since then he's taken advantage of opportunities due to the failing of credit markets. Is there really any need to question whether these investments presented great value?

Does this mean there's no value in equities? Of course not. It means there were better opportunities in the credit markets. If I could have loaned money to Harley Davidson at 17%, I would have.

Apr 16 02:43 PM

[Ricard:]

On Apr 16 02:43 PM Vox Rationalis wrote:

> "Are these examples of value investing within derivatives domain?"
>
>
> Yes!
>
> "...during 4Q2008 and/or 1Q2009 BRK offloaded significant position
> of his holdings in landmark US companies. Buffett is using BRK’s
> cash to invest in instruments which are not available to general
> public. Remember his preferred share at fixed 10% interest rate both
> in Goldman Sachs and GE!"
>
> These two are not unrelated. Buffett had an opportunity to exchange
> blue chip equity holdings with low dividends into blue chip equity
> holdings with high dividends. Who wouldn't do this?

Very well said. It highlights the pluses Buffett garnered in the deals succinctly.

Apr 16 02:50 PM

[Dividend Tree:]

Folks,
Calm down!
I am the author of this article. Check out this link
seekingalpha.com/autho...
Appears there has been an error when actual article is displayed. SeekingAlpha has been notified (and I am sure they are working on it).

Looking at comment trails, it does appear that folks agree to the premise of the article that Buffett's approach is value + business acumen (and not value alone). Value can be found anywhere stocks, bonds, national, international, derivatives, currency, etc. It is not limited to the stocks alone (and that's the value trap most of us individual investors fall in, not Buffett)

Folks, I do not think articles questions Buffett. Does it? The article is an attempt to question the "interpretations of his methodology". Just read last two paragraphs carefully (and hopefully understand the notion!).

Apr 16 02:54 PM

[Dividend Tree:]

Vox Rationalis,
All the points that you quoted and responded, doesn't that point towards shrewd business acumen ? And not value investing alone as one may read all over the place! Thanks for you comments though !

Apr 16 03:05 PM

[Social Media:]

Why doesn't he share BRK profits with his shareholders? what is point of value if one cannot enjoy the cash out of it?

Apr 16 03:10 PM

[Vox Rationalis:]

Dividend Tree wrote:

> Vox Rationalis,
> All the points that you quoted and responded, doesn't that point
> towards shrewd business acumen ? And not value investing alone as
> one may read all over the place! Thanks for you comments though !

I think you probably needed to provide your definitions of "value investing" and "business acumen." I believe Buffett would be the first to tell you, he is a capital allocator. He lets the business people run the businesses. So from that standpoint, his business acumen is unknown - he lets the experts take care of that.

Apr 16 03:37 PM

[Ricard:]

What is the difference? If you are able to spot the low cost producer that can weather any downturn, and invest in it due to your following of the value school of investing, couldn't you also say that such a school of thought encourages the development of a shrewd business acumen?

Indeed, Ben Graham ends one of his books (I think the Intelligent Investor) with the conclusion that the best investment operations are those that are also the most business-like.


On Apr 16 03:05 PM Dividend Tree wrote:

> Vox Rationalis,
> All the points that you quoted and responded, doesn't that point
> towards shrewd business acumen ? And not value investing alone as
> one may read all over the place! Thanks for you comments though !

Apr 16 03:37 PM

[Vox Rationalis:]

Social Media wrote:

> Why doesn't he share BRK profits with his shareholders? what is point
> of value if one cannot enjoy the cash out of it?

Simple. By not paying dividends, Berkshire allows shareholders to take all of their taxable gains at the time of their choosing, which can be greatly beneficial. Or to allow greatly appreciated shares to pass through their estates, which reduces the tax on gains to ZERO.

Few shareholders would argue that BRK's profits haven't benefited them, since their holdings have appreciated 1014% since 1/12/1990 (the oldest number on Yahoo), or a bit more than twice what the S&P 500's returned during that time.

Apr 16 03:53 PM

[mkreisel:]

Ben Graham constantly compares stocks to bonds. When investment grade bonds yield 7% or more, stocks at current earning yield (E/P) are just not attractive for Buffett.

Apr 24 02:14 AM