What you can learn from Warren Buffett’s bad day

You know those days when you look at your portfolio and you think: “What the hell happened today?”

(Admit it – you’ve had them. We all have.)

Well Warren Buffett, the World’s Greatest Investor Ever™, had one of those yesterday.

He lost nearly $1bn (on paper) from the value of his holding in IBM. And to make matters worse, another of his favourite stocks – Coke – disappointed too.

As I said, we all have bad days. But sometimes those are what give us our best learning experiences.

So what can we learn from Buffett’s? 

As Warren Buffett learned to his cost, sometimes moats are breached

Warren Buffett bought computing giant IBM in 2011 for his investment vehicle Berkshire Hathaway. It was his first big investment in the tech sector. He may or may not be wishing that he’d carried on avoiding it.

Yes, he suffered a paper loss of nearly $1bn yesterday. But as FT Alphaville points out, he’s “broadly flat” on the purchase, after accounting for dividends. And because IBM has been buying back its shares, he now owns around 7% of the company, rather than the 5.5% he originally bought.

Trouble is, it’s no good owning more of IBM if it isn’t going to turn itself around and become a big success story. And it’s not clear that it will. Revenues fell for the ninth quarter in a row. And IBM also had to pay a chipmaker $1.5bn to take its chip-making business off its hands.

To cut a long story short, IBM made its money selling hardware. Cloud computing – where companies effectively ‘rent’ hardware from the likes of Amazon – hit that business model. So it’s been trying to shift focus onto software and services.

But of course, it’s not easy to go from being dominant in one field to then changing your entire operation for another. It’s like being a great shot putter and deciding to become a long distance runner – your body is set up for a totally different sport.

Shortseller Doug Kass – who attended the last Berkshire Hathaway Q&A session with Buffett – points out that this is the potential problem with focusing on ‘moats’ and a ‘buy and hold forever’ strategy.

The idea is to own “profitable companies [with] moats that [provide] them with a nearly invulnerable market share position, sustainable profit margins and returns on invested capital, and superior earnings growth.”

The trouble is that eventually your moat can become your biggest handicap. A big portfolio of out-of-town hypermarkets is a fantastic barrier to entry in the supermarket sector. Until no one shops at them anymore, because they’re buying everything online.

And then they hold you back – because you have a great big pile of ‘legacy’ assets that are swallowing up resources you could be using for something else. 

It’s a similar problem – if on a smaller scale – for Coke. You might make the best sugary drink in the world. But what if people don’t want sugary drinks any more? You might launch healthy versions – but your brand is forever associated with and handicapped by your biggest product.

You could even argue the same for the drug development sector. One of the biggest moats for the likes of Pfizer and Glaxo is the regulatory environment, which makes it tough for smaller companies to get traction in the sector.

But as this comes under pressure – both because of government spending cuts and also because people want new drugs to hit the market faster – the nature of this moat will change too.

Buying Berkshire Hathaway back in the 1970s

Just to be clear – Buffett is an incredibly good investor. It’s easy to poke a bit of gentle fun at the folksy delivery style and the reverence with which he is generally treated. But I fundamentally agree with the value investing approach that he’s associated with, and he’s also great at communicating this to other investors.

The trouble is, value investing isn’t really what he’s doing these days. Berkshire’s sheer size – as Buffett himself has pointed out – means that now he has to hunt for decent companies at reasonable prices, rather than potentially fantastic companies at bargain prices.

In an era where lots of big industries face serious risk of disruption, from the oil business to the payments industry to the grocery sector, that’s not necessarily as safe a strategy as it might look.

Combine that with the unquestionable issue of succession management risk, and I can’t say I’d be desperately excited about the idea of buying Berkshire Hathaway right now.

However, at our last Roundtable, one of our experts dug up a stock that he reckons is a bit like buying into Berkshire Hathaway back in the 1970s – and that is a very tempting proposition. You can read the piece here  – if you’re not already a subscriber get your first four issues free here.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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