Six Keys to Investing Buffett Style
Buying low isn't enough. You need to see the future
A big reason that Buffett avoided technology stocks in the late 1990s was that he could not identify any firms with a wide enough moat. So when Buffett said the tech sector was "beyond me," he wasn't claiming ignorance. What he really meant was that technological advances in this sector were coming so rapidly that it was impossible to gauge with any clarity which companies and platforms would have a competitive advantage 18 months down the road. This would explain why even blue-chip companies like the networking giant Cisco Systems or the microchip manufacturer Intel never made it into Berkshire Hathaway's portfolio even after their shares took a big hit in the 2000 bear market.
When you bet, bet big. Most value investors are conservative by nature. The average manager of a value stock fund spreads his or her bets among 146 different stocks, according to fund tracker Morningstar. Not Buffett. The $62 billion that he has invested in publicly traded stocks is concentrated in only about 45 names.
His strategy is even more aggressive than this statistic would suggest. His top 10 stock picks account for a stunning 90 percent of his publicly traded portfolio. "This concentration is consistent with what Mr. Buffett has said in the past: 'Don't swing a lot, but if you do swing, swing for the fences,'" says Justin Fuller, a Morningstar senior equity analyst. Or, asks Bruce Berkowitz, comanager of the Buffett-loving Fairholme Fund in Short Hills, N.J.: "Why in the world would you want to invest in your 30th-best idea, as opposed to your best idea?"
Of course, this type of thinking takes moxie. You have to be totally confident that your best ideas will outperform the field. In the right hands, though, this risky approach can work: A quick analysis by U.S. News using data from Morningstar shows that value-oriented stock funds with fewer than 50 stocks have outperformed the average value portfolio with more than 50 holdings over the past one-, three-, five-, 10-, and 15-year periods.
Don't be afraid to wait. If you take big swings in the stock market, as Buffett does, there's a big risk of striking out. Buffett's rule: Don't swing that often. And don't swing at bad pitches.
Buffett has quoted legendary Red Sox slugger Ted Williams: "To be a good hitter, you've got to get a good ball to hit." And until Buffett gets such an investing pitch, he's more than willing to hold cash. "He's understood something that people don't appreciate: Having large amounts of cash doesn't have to hurt your performance," Berkowitz says. "Cash can be a strategic asset." Cash currently represents more than 18 percent of Berkshire Hathaway's investment allocation, according to Morningstar, versus just 4 percent for the typical value stock fund.
This doesn't mean that Buffett doesn't want to maximize his gains at all times. Like Gordon Gekko, he believes "greed is good." But like the quintessential value investor he is, Buffett believes that you have to be patient when exercising that greed. As he has often said, "Be greedy when others are fearful and fearful when others are greedy."