What's the Smartest Money Doing? Buffett's Buying Goldman Sachs

Warren Buffett is one of the richest men in America. His investment expertise has put billions in his own pockets and made many millionaires out of those who invested in his primary investment vehicle, Berkshire Hathaway (NYSE: BRK.A). Buffett's track record of successful gains while avoiding big losses is among the best in the world.

So what is Warren Buffett buying now? He's buying investment banks. That's right, in the middle of what may be the worst banking crisis in the last 75 years, the man who is arguably the greatest living stock-picker is putting his money in investment banking. According to Bloomberg, he is purchasing $5 billion in perpetually preferred stock in Goldman-Sachs (NYSE: GS). This preferred stock has a guaranteed 10% annual dividend. That means Warren Buffett will make a half billion dollars every year that he holds this investment if the value of the shares don't change at all. Of course, Goldman-Sachs maintains the option to buy the shares back from Buffett at any time - so long as they add a 10% kicker on top of the current value.

But wait, there's more. Buffett is also getting another $5 billion worth of warrants to buy ordinary shares of Goldman-Sachs at $115/ share. By the way, the shares closed Tuesday at $125.05 or 8% more than the amount Buffett would have to pay if he exercised his warrants. Remember also that Goldman-Sachs has traded above $169/ share as recently as September 8th, but has been hammered like most other financials as the banking crisis has unfolded. Warren Buffett is credited with many pearls of investment wisdom, among them is this quote: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." Right now, there is certainly plenty of fear when it comes to the financial sector. So it certainly makes sense that Buffett would be the first one to start buying.

Now don't get us wrong, he's not buying willy-nilly just because other people are running away. He is picking the babies from the bath water. There are financial stocks that are healthy and which will weather this storm and continue to make large profits for many years. Warrant Buffett has never been a short-term investor. He has said, "Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years."

Clearly, there are some large banks for which, as Buffett also put it, "the only time to buy these is on a day with no 'y' in it." The trick is to separate the wheat from the chaff. One way to do that is to watch what successful investors like Warren Buffett do. Read that carefully, don't follow what other investors say, follow what they do with their own money. It is not unheard of for Wall Street "insiders" to tout a company's virtues as they sell it in order to get the price they want from people who listen to their advice. Investment personality Jim Cramer admitted as much in an interview with The Street.com, calling the practice widespread and saying it was practiced on a daily basis by most successful fund managers.

Follow, instead, successful long-term investors. These people buy good companies and hold onto them while their good business practices reap profits. Increasing profit over time eventually means higher stock prices, no matter what happens in the short term.

Disclosure: none

Comments

[paulchan:]

the us treasury's $700 bn bailout plan should be scrapped and replaced by something like Buffet's deal. it is a fair deal, with reasonable amount of risk compensated by the prospects of good return. the taxpayers will be happy, the banks that get the injection will be happy, the markets will be happy

2008 Sep 24 06:53 PM

[Vox Rationalis:]

Haven't seen the actual deal, but my understanding is that the BRK preferred will not trade, nor appreciate. They're exactly like a 10% bond with a 10% call premium, except that as equity they boost the balance sheet. Expect them to be called as soon as Goldman is comfortable with its new position in a recovering financial marketplace.

2008 Sep 24 06:58 PM

[Kath H.:]

Maybe Buffett is very concerned that a failure of the passage of the bailout would cause such a problem that his entire wealth would decrease significantly. By showing faith in Goldman, perhaps he feels he can create support for the bailout and hence be better off. His decision may have nothing to do with Goldman's potential to make a profit for him itself.

2008 Sep 24 07:42 PM

[HLO:]

Buffett's getting a whopper of a deal. The 10% return Berkshire receives will be 80% exempt from taxation, which equates to around a 15% return if it were fully taxed. On top of that, Berkshire obviously gets the warrants. Depending on what the value of the warrants are, it's likely that Buffett's total return is well over 20% on an equivalent fully taxed basis.

2008 Sep 24 08:23 PM

[SunevaLight...:]

All this angst, hoopla and dealmaking scenarios might be impressive but it still fails to address the core of the problem - the greed mindset that seems oblivious to the damage they leave in their wake. All of these folks belong at www.greedypeople.com--... least they have a clue, which the Treasury seems to be missing.

2008 Sep 24 09:45 PM

[venividivici:]

It's a fantastic deal for Buffet and it shows just how desperate Goldman is for cash. But I agree with you Kath H. This is all about all hands to the bilge pumps on the SS Titanic. I recall Soros put $250 million into Lehman shares. Gee I wonder if he got any of that great investment out.

2008 Sep 24 10:42 PM

[Norman Lepo...:]

Good article and comments. Thanks.

2008 Sep 25 12:06 AM

[GKM:]

So how is it I replicate Warren's deal exactly? I don't understand. Is this author just dense, dim witted or is s/he being facetious? Even Buffett doesn't believe the value of GS is the current market price. Otherwise the strike on the warrants would be something like $175.

2008 Sep 25 12:19 AM