Warren Buffett is "the greatest investor of all time", reckons the BBC's Evan Davis and countless other admirers. So why not save yourself the time and hassle of stock research, and just copy the master? After all, if you'd replicated his trades between 1976 and 2006, you would have beaten the S&P 500 index by 10.75% per year, reckons the London School of Economics.
But before you rush off to check out Buffett's latest trades, be warned the copycat trade is unlikely to work so well over the next 30 years. Repeating many of Buffett's big moves these days is either tough or impossible. Take his latest deal (at $34bn, his biggest yet) to buy railroad operator Burlington Northern Santa Fe Corp. Buffett is buying the entire company, so you can't copy him this time.
The same goes for his deal to buy into investment bank Goldman Sachs in 2008. Buffett was offered $5bn of 'perpetual' preferred securities paying 10% a year and warrants to pick up close to a 10% stake in the bank at a discounted price. His stake in General Electric was bought on similar terms. Those aren't the sorts of plain vanilla deals your average retail investor gets access to.
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There's also the problem of motivation. Like anyone who runs a portfolio of assets, Buffett has an overall investment strategy and that's known only to him and his investing partner, Charlie Munger. So he might make a purchase in one sector to offset exposure to another, or for tax purposes. Not every deal will be based purely on his value investing principles. Burlington, for example, was not an obvious bargain. On a forward 2010 p/e of around 18, it was trading well above the S&P 500 average for this year of 15.4. So cherry-picking only those of Buffett's trades that you can actually follow means you're unlikely to generate the same returns as he does.
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Then there's the herding effect. Buffett has appealed in the past for an exemption from having to disclose his stock deals; such is the impact they can have on prices. So you won't get into a stock at anywhere near the same price as him. And watch out for trading costs Buffett is well connected and always buys big, so he enjoys discounts on both price and costs that the rest of us can only dream of.
So why not simply buy Berkshire Hathaway instead?
The obvious way to sidestep these issues is not to copy Buffett's deals one by one. Instead, just buy his investment company Berkshire Hathaway (NYSE: BRK-A). But there are problems with this approach too. First there's the price. There are two classes in issue: the A shares trade at around $101,000 each and the B shares, typically at 1/30th of that, or nearer $3,300 at current prices. The good news is that Buffett is planning a 50-for-1 stock split that will significantly bring down the average price of the B shares to nearer $60-$70. But even so, we'd be wary.
Buffett is nearly 80 years old. Who would bet on any successor being able to match him? The odds seem slim. As Nicholas Colas, chief market strategist at brokerage BNY ConvergEx puts it, "if Steve Jobs is critical to Apple, Warren is ten times more critical to Berkshire". And the stock-split decision suggests Buffett knows this too. The reason given for the split it to allow small Burlington shareholders to choose to take tax-free shares in Berkshire. But as Geoffrey Rogow at Dow Jones notes, the 50-to-1 deal would also increase turnover of Berkshire's shares to a point where they would be eligible for inclusion in the S&P 500 index. Once there, institutional shareholders, including S&P 500 trackers, would be less likely to dump Berkshire en masse when Buffett steps down.
Another reason to be cautious is that Berkshire is not the firm it once was. Many of Buffett's most successful deals were relatively small ones, done years ago before he made his name. Now he's in the full glare of the media spotlight, and has little choice but to buy big and publicly. So it's harder for him to capitalise on any bargains he spots. As Jim Slater once commented, "elephants don't gallop" and these days Berkshire is pretty long in the tusk.
While most investors have suffered in this downturn, Buffett's been hit particularly hard. Last year was his worst ever, and Berkshire shares are still 26% off their 2007 peak. Credit-rating agency Standard & Poor's has warned that the group may lose its AAA credit rating after the Burlington deal there are fears over the deals' impact on cash flow, given the poorly state of some of Buffett's other businesses, including his insurance arm.
Finally, don't be fooled by Berkshire's recent strong share-price rise following its third-quarter results. The results release notes that "restricted access to credit markets... in the future" which seems very likely to happen once central bank stimulus ends could have a "significant negative impact on operations". Buffett may be an all-time great, but we don't think now is the time to pile into Berkshire Hathaway.
