Warren Buffett’s latest annual letter to shareholders demonstrates once again that the world’s greatest investor marches to his own drummer.
The letter, published Friday, shows that Mr. Buffett’s flagship company, Berkshire Hathaway Inc., continues to hold a highly concentrated portfolio. About 64 per cent of its holdings are in only five stocks.
Mr. Buffett has held a concentrated portfolio throughout his illustrious career, making a mockery of the modern portfolio theory taught in universities around the world, which holds that wide diversification among hundreds of stocks is desirable.
But while Mr. Buffett has always believed in the benefits of holding highly concentrated portfolios, his opinion about what kind of stocks to invest in has evolved over the years. Investors who want to emulate the Oracle of Omaha should ponder the lessons of his career.
Mr. Buffett’s current policy is to buy great companies at reasonable prices. His portfolio is focused on market leaders, such as Coca-Cola, American Express and Wells Fargo, that he has held for years. Once he invests in a great company, he says he wouldn’t care whether the markets were to close for the next three years. He buys and holds as if he were the owner; he never buys and sells as a trader.
Mr. Buffett’s recent deal to buy H.J. Heinz Co. is a perfect fit for his philosophy. In many ways, the ketchup maker is like Coca-Cola. Both have intergenerational customer captivity – an extremely rare thing – forged out of habits built up while consumers are children. For these stocks the best strategy is to buy and hold – you never sell, as their intrinsic value is always one step ahead of the stock price.
But Mr. Buffett has been having difficulty finding deals of this quality nowadays. He says he is searching for the mega-sized deals he calls “elephants,” but fewer and fewer such opportunities are coming his way. As a result, his recent performance has been lagging his historical record.
At times like this, it’s important for people to remember that Mr. Buffett was not always the type of investor we now see.
During his early years, he was a far more opportunistic buyer. Back then, he adhered closely to the teachings of Ben Graham, his teacher at Columbia, and managed to achieve outstanding results with a style that is far different than his current fashion.
The young Mr. Buffett invested in unloved and obscure companies – ones that had prices that were cheap in comparison to their earnings and book values. He liked small, less liquid companies and, in many cases, ones that were in outright distress.
Buying companies like this can generate enormous riches – it certainly did for Mr. Buffett in his early years.
So why has he changed? One big reason is that he has been so successful that he now has too much money to invest.
Unable to nip in and out of tiny stocks the way he once did, he has had to focus on large, liquid and well-known companies. These are generally more expensive than the ones he bought in his youth and are unlikely to double or triple the way some of his early picks did. Giant companies tend to be well covered by analysts; the chances of them being terribly undervalued are lower than for the stocks Mr. Buffett used to invest in.
What should investors learn from Mr. Buffett’s career? One key point is that value investors do not always buy and hold. They buy and hold only the kind of companies that Mr. Buffett is investing in now.
For the rest, they look for opportunities to buy low and sell high – an investing style that, implemented properly, can also result in tremendous profits, even if it seems to be at odds with what Mr. Buffett is doing now.