They say Warren Buffett eats McDonald’s multiple times a week, gulps down a few cans of Coke a day and prefers ice cream and candy over vegetables. According to one former CEO who knows Buffett, when he uses the saltshaker it’s like a “snowstorm”. These aren’t the eating habits I’d want to be teaching my kids, but then again Buffett’s diet isn’t what we admire about him. We admire his track record, investing prowess, long-term thinking, optimism in America, his communication abilities and the sound and consistent investment advice he has shared with millions of investors. But in studying Buffett and looking at his portfolio and actions, it might be more of a story of “do as I say, not as I do”.
Here are a four things Buffett actually does that most investors shouldn’t, or couldn’t, do with their own money or portfolios.
Building Cash and Market Timing
The dramatic decline in stocks early in the year and their nearly as powerful rebound highlights the risk of market timing. Missing rebounds like this can wreak havoc on your long-term returns. The phrase “time in the market is more important than timing the market” is something espoused by advisors and buy-and-hold investors alike. Timing the market can come in many forms. You can take a portion of your portfolio out of stocks and then look to buy back in. That’s one form of timing. Another way is to use cash flows to try to time opportunistic purchases, which is effectively what Buffett is doing.
At the end of 2008, Berkshire Hathaway had roughly $25B in cash on its’s balance sheet. As of September 30th, 2020, the cash balance was roughly $146B according to YCharts. As Berkshire’s operating businesses kick off profits, those profits become cash on its balance sheet and provide the dry powder Buffett uses to buy stocks and companies outright. But due to a myriad of reasons (a limited universe, high valuations) the cash has been building BY A LOT!
It’s similar to an individual investor, who’s working and contributing to a retirement account like a 401K. Imagine if each month some of your earnings went into cash in your investment account vs. being invested. At some point, you would look to deploy that long-term money into the market but by not putting it in immediately you’d effectively be making a timing call.
Since the end of 2008, the S&P 500 is up over 360% including dividends. Buffett has had a consistent and growing cash balance that now equals more than only a few dozen companies total market valuations. One wonders if Buffett would have just put most of the cash in the S&P 500 ETF, what the value of that cash would be today.
That may be one important lesson in this: Getting broad market exposure, at least for most investors, may be even more important for most investors vs. looking for that perfect investment.
An Uber-Concentrated Stock Portfolio
As of the day of this writing, Apple accounts for 46% of Berkshire’s $250B in public equity holdings. After that, you have Coca-Cola, Bank of America, America Express and Kraft Heinz. When you total those five positions, they make up close to 80% of Berkshire’s total stock exposure. That’s concentration.
The image below shows visually just how large these positions are compared to the other stocks Buffett owns. Apple has been a huge winning position for Buffett, so the overweight in that name is a result of the stock being a stellar performer over the past few years, but the point is most investors shouldn’t look at Buffett’s positions and weightings of the companies he owns and think that is the best way to run their portfolio. Most people should be more diversified with their stock positions. Holding between 30-60 names gets you most of the benefits of diversification, but having more balance between positions would likely serve most investors well.
Source: CNBC BERKSHIRE HATHAWAY PORTFOLIO TRACKER, Flourish Charts
Pivoting and Letting Your Winners Run
In Morgan Housel’s new book, “The Psychology of Money”, he writes:
“At the Berkshire Hathaway shareholder meeting in 2013 Warren Buffett said he’s owned 400 to 500 companies during his life and made most of his money on 10 of them. Charlie Munger followed up: ‘If you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.’”
Some people think Buffett rarely sells his stocks, but that’s just wrong. Buffett had 10% stakes in all the major airlines coming into this year. He sold every one of them during the COVID shutdown on fears their businesses would be permanent damaged or the U.S. Government was going to have to provide capital and dilute equity holders. In the latest 13F, he’s moved out of many of his financial positions and added big pharma names and even pruned a little of his Apple position.
As Sparkline Capital’s Kai Wu pointed out in a research piece from earlier in the year, Buffett started his investing career as a traditional Ben Graham style value investor, looking for stocks that were cheap based on their assets. But this deep value approach was limited, both in terms of its scalability and the opportunities, so Buffett migrated to a high-quality investing approach, looking for moats and companies with consistent profits and above average profitability. He’s continued to adapt this style and approach, adding Apple in 2016 and acknowledging the importance of intangible assets.
The ability to look at the facts, change your investing approach and find new opportunities might be one of Buffett’s greatest skills, but most investors wouldn’t be able to pivot like Buffett. And therein lies the challenge. Trying to emulate Buffett’s adaptability and rationality just isn’t doable for most investors.
Creative Tax Moves
Just to make one thing very clear, Berkshire pays a significant amount in taxes. Actually, Berkshire paid 1.5% of all corporate taxes in 2019. In Buffett’s 2019 Annual Letter to shareholders, he wrote:
“In 2019, Berkshire sent $3.6 billion to the U.S. Treasury to pay its current income tax. The U.S. government collected $243 billion from corporate income tax payments during the same period. From these statistics, you can take pride that your company delivered 1-1/2% of the federal income taxes paid by all of corporate America.”
But that is not to say that Buffett hasn’t gotten creative in the past to alleviate some of the tax burden that would have been owed if he were to sell certain stock positions. In 2014, for example Buffett and Graham Holdings struck an asset swap deal in which Berkshire gave Graham back the shares it owned and in return Graham provided Berkshire with a Miami TV station, cash and shares it owned of Berkshire. He’s done this a few other times as well in the past, resulting in a net tax savings vs. selling outright in the open market and having the sale be a taxable transaction for Berkshire.
Remember, You’re Not Buffett
So, there you have it, Buffett is a market timer, a super-concentrated investor, not as disciplined as you think and has, through the use of asset swaps, avoided taxable gains. On the surface, most investors should stay clear of trying to put these principles and techniques into action in their investment strategy, which is why Buffett actually recommends individuals just buy the S&P 500 and call it a day. But there will always be investors looking to beat the market and they will look to Buffett as an inspiration, even if many of his actions aren’t appropriate for most investors.
Justin J. Carbonneau is VP at Validea & Partner at Validea Capital Management.
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