Don’t blindly copy Warren Buffett

If you’re even a halfway serious investor, chances are that you’ve tuned into Berkshire Hathaway’s 2016 shareholder jamboree that concluded this week. The business media is flooded with Buffet and Munger sound bytes and the video has just topped a million views.

While it makes a lot of sense for every investor to understand how Buffett has created so much equity wealth, blindly copying his strategies for your own portfolio is quite a bad idea. Here are three pieces of Buffett advice that ordinary investors mustn’t follow.

Buffett and Munger are great advocates of concentrated stock portfolios. If they have conviction about a business and its management, they love to bet big money on it.

The December 2015 portfolio of Berkshire Hathaway shows that they walk the talk.

Just the top five equity bets — Wells Fargo (19.8 per cent), Kraft Heinz (17.9 per cent), Coca Cola (13 per cent), IBM (8.5 per cent) and American Express (8 per cent) — made up two-thirds of the $131 billion portfolio.

But if you’re thinking of emulating this by making 15 to 20 per cent bets on individual stocks, better hold off. While that kind of concentration may work for someone with Buffett’s stock picking skills, they certainly don’t work for you and me.

Before Buffett & Co make those billion-dollar bets on any business, they put in enormous legwork into studying the nuts and bolts of it. Berkshire has dedicated analysts to pore over a firm’s statutory filings, visit their plants, talk to suppliers and get an inside line to the business from competitors.

Also, think of the clout that Buffett must have with company managements, private investors and policymakers.

All he needs is a phone call to get access to industry insights that aren’t in the public domain.

It is this kind of homework, not to talk of five decades of investing experience, that helps Buffett and Munger gain the conviction they need to make those 15-20 per cent stock bets.

Ordinary investors would rarely have the skills or the time to devote this much attention to their stock picks. So it is best for them to cap stock exposures to the same limits as mutual funds — 5 to 10 per cent of the portfolio.

Of all the investment nuggets from Buffett and Munger over the years, the most-abused one must be about buying businesses with wide “moats.” Here’s how Buffett explained the concept to college students many years ago.

“Take Coca Cola. It’s a simple business. It’s not an easy business. I don’t want a business that’s easy for competitors. I want a business with a moat around it. I want a very valuable castle in the middle. And then I want the Duke who’s in charge of that castle to be honest and hard working and able. That moat can be various things”.

Buffett’s idea of a wide moat is essentially anything that protects a business from attack by new competitors — a strong brand, an entrenched distribution, ultra-low costs, or a patent that prevents copying.

It is this moat theory that has resulted in stocks such as Coca Cola, P&G, Gillette and WABCO Holdings making it to the Berkshire portfolio at different points in time.

But the ‘moat’ theory has by now become so popular with investors in India, that most businesses with a ‘moat’ have already been unearthed and bid up to the stratosphere.

The Indian arms of the ‘moat’ firms that Buffett likes have been particularly fancied.

So you have P&G Hygiene and Healthcare trading at a price-earnings multiple of 58 times (Source:Bloomberg), Gillette India at 67 times and WABCO India at 88 times, while their global parents trade at 19-21 times.

At these prices, it is doubtful if Buffett himself, a value investor, would buy these stocks. So yes, look for businesses with enduring brands or competitive advantage, but don’t ignore valuations.

Another oft-cited nugget from Buffett is that Berkshire’s favourite holding period for a stock is ‘forever’. Now, many investors take that to mean that, once they’ve bought a stock they like, backed by a great business, they can forget about it for the next 20 or 30 years, to mint money.

In India though, such passive strategies are a sure-fire way to decimate your wealth. Even over shorter time frames of 10 years or so, business cycles can change, sectors can go from boom to bust and governance problems decimate once-fancied stocks.

Remember SSI and Pentamedia Graphics in the late nineties or Lanco Infratech and Unitech in 2006-08, which professional investors thought would create wealth in perpetuity? But these stocks are down 80-90 per cent from their peak prices.

Bull market excesses apart, there are other examples of ‘idea’ stocks too (for instance, OnMobile Global, Bartronics, Pantaloon Retail) that have left their long-term investors high and dry.

When Buffett says that he plans to hold a stock forever, what he plans is to track it so closely (using his top-notch investment staff), that he has the confidence to hold on to it forever.

Make no mistake - in the case of management mis-steps or floundering profits, Buffett is pragmatic enough to sell his holdings in double-quick time.

Buffett did go wrong in acquiring US airline stocks in the nineties, ConocoPhillips amid soaring oil prices and Tesco, ahead of an accounting scandal. But he has quickly unwound the bets and moved on.

This is probably why he qualified this quote as “When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.”

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