Dispelling The Fallacy of "Buffett Can't Buy More"

Since my initial post of Berkshires' (BRK.A) WEB and the replies, there has been quite a bit of discussion on the topic out there.

Here are the initial posts - here and here. If you read them we will be on the same page.

Recently the line of thinking out there is that Berkshire's size and the various SEC regulations surrounding stock purchases prohibits large stakes in public companies at prices Buffett is willing to pay. It says that because Berkshire can only buy up to 1% of a company's daily volume without disclosing it is doing so, it cannot make purchases of a percentage to Berkshire's size that it did in the past. Essentially, when you are a $100 million company investing 20% in a single stock, is a whole lot easier than investing 20% of the approx. $50 billion that Buffett sits on today. This is all very true, but here is the rub: If we look at a few of the Berkshire purchases the last few years, this reasoning for Berkshire not buying more just does not hold water.

In order to continue, we need some agreement on a couple of things:

1- Buffett only buys stocks he considers a value
2- He would not invest expecting only a "small return" on an equity. This is despite his public proclamations; this is called "under promising and over delivering." He has been saying essentially the same things for the past two decades. Not buying it anymore.

Wal-Mart (WMT)

Berkshire first announced a Wal-Mart stake in 6/2005 and added to it in 9/2005 for a total of 34 millions shares at an average price of about $48 a share. The prevailing thinking out there now is that Buffett just could not buy more once the initial stake was announced because copy-cats poured into the stock and pushed the price above a level Buffett would be willing to pay. But Wal-Mart has essentially traded at or below Buffett's purchase prices since he bought shares! He could easily have made Wal-Mart a substantial Berkshire holding. When you consider Wal-Mart trades 13 million shares a day, Buffet could have bought about 760,000 shares a day.

Johnson & Johnson (JNJ)

In the spring and summer of 2006, Buffett bought 26 million shares of JNJ at $59 a share. He sat there for the next year as the stock price fluctuated around the almost $64 a share price at which he bought another 22 million shares in the spring of 2007. Berkshire now owns 48 million JNJ shares that represent just under 3% of Berkshire's assets. Could Berkshire have bought much more at prices he clearly was willing to pay in the past year and a half? Yes. JNJ trades almost 9 million shares a day and even with Buffett gobbling up 22 million more shares, the price of JNJ stock fell precipitously during the spring of 2007 from $67 to $60. This means that even with him purchasing just about the maximum number of shares in order to avoid public reporting, his activity did nothing to cause a "jump" in the stock price.

These are just two quick examples. Now, there may be many reasons Buffett did not take bigger stakes. Since he has never said, we will never really know. What we do know is that the common excuse "he just can't do it because of SEC regulations and reporting requirements" just does not wash. Even Munger inexplicably jumped on this bandwagon recently when he claimed as much.

Now for some of the smaller companies Berkshire has taken stakes in. This is entirely true, but the above reasoning is being used to eliminate any discussion of why Berkshire stopped "swinging for the fences" almost decades ago. If you dig deeper into purchases that past three years, there are many examples of companies Berkshire took stakes in that the opportunity to take much larger stakes at or below the original purchase price was there [U.S. Bancorp (USB), for example] - they just chose not to. It had nothing to do with the recently espoused reasons.

Additionally, let's not forget that Buffett is one of the few folks out there that the SEC actually allows to delay reporting of purchases while he finishes building his positions. Even without this grace period and even after his stake has been announced, a larger position in Budweiser (BUD) was available.

Warren "can" build Berkshire portfolio changing positions, he just "chooses" not to. That is ok, but let's just admit that and let go of the excuses.

Disclosure: Author is long WMT.

Comments

[wixeywaxy:]

My observations are that in spite of his historical record, the publically announced purchases frequently don't show all that great of a return. The several specific acquisitions you list above show that pattern as well. For my part, I think individuals who base investment decesions on the publically reported activity of Warren Buffett are using questionable investment technique. That's not to say that I don't think that he is a very smart man. Vic

2007 Jul 16 10:03 AM

[jon edwards:]

Not every position is a Buffett position, they can come from Lou Simpson, who runs the GEICO portfolio, which is considerably smaller

2007 Jul 16 07:19 PM

[gembree:]

WEB has said repeatedly he thinks stocks are valued to give lousy returns recently, and IMO market overvaluation is much more harmful to him now than it was in 1969, because his universe of potential investments is a lot smaller, with fewer mispriced securities. Furthermore, it seems likely he shares Grantham's view that the current overvaluation persists across asset classes. One hint would be that his current large bet is in currencies again, which are valued relative to each other rather than absolutely.

When Buffett says to buy shares only if you would buy the whole company, he is saying two things - first that a share of stock should be valued as a fraction of a whole company, according to Benjamin Graham's approach, and secondly that buying whole companies is always preferable to buying stock in companies, because of the tax and other benefits that accrue to Berkshire that way. It doesn't necessarily follow that it is better to buy ten million shares than a hundred thousand. While I don't think Buffett uses the Kelly criterion as such, his intuition about sizing his bets seems to run along similar lines.

I think that he could buy more, but that he foresees better values in the future, and doesn't want to commit a lot of money toward a decent return when excellent returns will eventually come back in vogue. You're quite right that he could make bigger bets, but it takes time, and it would take time to liquidate them at a profit. If he's sitting on cash, it's because he wants to be ready for something.

2007 Jul 17 10:24 AM