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Warren Buffett’s Investing Strategy
The Smart Profits Report: Issue #343
Monday, August 14, 2006
Warren Buffett’s Investing Strategy: The Master of the “Buy and Hold”
By Karim Rahemtulla
Chairman, Mt. Vernon Research
Just when you thought the notion of long-term “buy and hold” was a dying investment strategy, along with the investors who subscribe to it, we’re reminded that there are still some great long-term investors in the world.
To watch this “buy and hold” strategy in action let’s take a look at Warren Buffett’s investing strategy. When you mention Buffett’s name, it immediately sparks an image of an old (yet energetic) man with an uncanny ability to pick good stocks, and a $44 billion fortune. (Of course, he recently donated $30 billion to the Bill & Melinda Gates Foundation - thought to be the biggest non-governmental donation in modern finance).
While that’s certainly striking, Warren Buffett has another key quality that’s perhaps even more impressive…
How to Invest Without Flinching
As with any investor, Buffett has not only enjoyed his share of winners, he’s also suffered losses. But it’s the way in which he’s responded to those losers that is notable - specifically, his extraordinary ability to withstand a dramatic decline in the share prices of his losing picks without flinching.
Let’s look at one his big holdings, USG Corp for example…
As the dominant manufacturer of drywall, USG was the premier way to play the U.S. housing boom. Warren Buffett realized this and bought shares when they were trading around $20. But throughout the housing boom, USG was mired in Chapter 11 bankruptcy, due to asbestos-related lawsuits.
Time to sell? Nope. Buffet held on - a decision that proved to be an extremely lucrative one, as USG raced up to $121.70 at its peak on April 25 this year. But rather than take the money and run, Warren still held on.
Then came the double whammy…
Would You Buy More Shares After a 157% Loss? Buffett Does.
First, USG announced it had reached a settlement for its asbestos-related problems - a settlement that would cost the company almost $4 billion. But the only way to pay this and emerge from bankruptcy was to initiate a rights offering, which entails raising more money from existing shareholders, and paying it out of the company’s coffers. The second whammy, of course, was a cooling in the housing market. And housing equals less housing-related materials.
Result? USG shares have plunged from the heady heights of $121 to around $47 today. Surely, this is the cue for Buffett to sell? No. While he could have sold at the top, or near to it, he chose not to, and has ridden the stock all the way down.
In fact, rather than heading for the exit, Warren Buffett is actually adding to his position both through the rights offering, as well as the open market - to the tune of tens of millions of dollars.
So what gives? Is Buffett crazy? Or does he see opportunity while others are panicking?
Three Reasons Why Buffett Is Putting His Money Where His Mouth Is
There are three possible answers…
- First, on a macroeconomic level, Warren Buffett could believe that the global construction boom is not over, but merely experiencing a correction. If so, holding a company like USG would prove valuable because it’s oversold to a point where the valuation at 9 times earnings is attractive to him.
- Second, he can’t sell now. If he did, he would spark a huge meltdown in the share price that would actually backfire on him, because it would make it more difficult for him to sell his remaining holdings. Not that he would have lost money if he sold before the rights offering, but as it is, his cost now is probably closer to $30 because of the more expensive shares he just purchased.
- Third, the government is going back and forth about setting up an asbestos trust fund. If that happens, it could reduce USG’s liability and may result in the company actually recouping some of its outlay from the recent settlement. In that case, shares would be worth more in a heartbeat.
Regardless of Warren Buffett’s true intentions, it is important to note that he is now putting his money where his mouth is. After its recent slump, there are signs that USG is oversold and shares are beginning to respond.
Learning From Warren Buffett’s Investing Strategy
So what can you learn from the “Warren Buffett’s Investing Strategy?” In short, waiting for a “sell bell” to ring at the bottom for any particular stock might leave you deaf and poor. Do your research and keep a close eye on developments that could result in a rebound. And with USG, Buffett is sending investors a signal that he thinks the worst is over.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- You’ve seen an example of how, despite major moves against his position, Warren Buffett decided to hold his shares anyway. But what if you can’t afford to give a stock much leeway? Knowing when to sell becomes a crucial decision. For a simple strategy on how to avoid absorbing a big loss read Smart Profits #133, Trailing Stops: How to Give Your Options Room to Grow.
- And to minimize the chances of having to take losses on your investments, you need to check out our essential guide in Smart Profits #178, Become a Better Trader: Small Changes You Can Make for Big Profits.
Related Articles:
- Stop Loss: Three Reasons to Get Out of a Trade Before it Hits Your Trailing Stop
- Option Losses: How to Grow Rich From Your Options Losses
- Option Pitfalls: Avoid These Five Options “Red Flags”
