In the latest Berkshire Hathaway annual report, Buffett provides his usual insight into the current markets along with one item that might shock most casual Buffett watchers.
He trades stocks.
Warren Buffett has said that his preferred holding period for stocks is “forever,” and he does hold some companies for decades, but he also sells when he thinks he needs to.
For instance, Buffett was once among the largest shareholders of Fannie Mae and Freddie Mac but sold long before the housing meltdown decimated their stock prices.
Buffett was also once a large shareholder of PetroChina. In his previous letter to investors, Buffett explained why he sold PetroChina, saying that his previous purchases put the value of the company at $37 billion, while he and partner Charlie Munger felt it was really worth $100 billion.
A rising oil price and good management pushed the share price up to a point where the market began to value PetroChina at $275 billion, well over Buffett and Munger’s estimate. So they got out, turning their $488 million investment into $4 billion in the process.
That lesson is easy to understand: When the market significantly overvalues your stock, sell it and put the cash to work in a better opportunity. Buffett sold near the top. PetroChina subsequently fell by more than 75 percent.
In 2008, Buffett made several large purchases. Before the financial crisis hit, he loaned money to candy maker Mars to buy Wrigley. As markets plummeted, he bought preferred shares of Goldman Sachs and General Electric with a 10 percent yield.
Later he bought a small amount of debt in luxury retailer Tiffany with a 10 percent yield.
In the current investment environment, it seems that Buffett thinks a 10 percent yield is a fair price to accept some risk. That fact alone is valuable insight for individuals — find a safe investment that pays enough to compensate you for waiting until other opportunities come along.
While ordinary investors like us will not be able to easily find 10 percent yields (Buffett certainly has a uniquely strong negotiating position), we should look at stocks with high dividends and steady earnings.
Another lesson from Buffett that might surprise: Like all investors, it turns out that Buffett feels he has limited cash available to hunt for bargains.
He wrote, “To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips).”
Selling involves not only cashing in when the market overvalues your holdings but looking at comparative returns and going after the highest ones.
While Buffett may have wanted to hold onto Johnson & Johnson, Procter & Gamble and ConocoPhillips, he felt that other investments offered higher returns and he went after what he believed were better opportunities.
“I have pledged — to you, the rating agencies and myself — to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits,” he told investors.
And, even though he believes “…cash is earning close to nothing and will surely find its purchasing power eroded over time,” Buffett is holding more than $25 billion in cash because he feels he needs that amount as an emergency reserve.
Interestingly, this represents close to six months of float in his insurance companies. Financial planners often tell individuals they should keep three to six months worth of cash in an emergency fund.
Whether by accident or design, Buffett seems to be doing the same thing. Given his extraordinary track record, it seems unlikely that any of his financial decisions are accidental.
Investors who think Buffett buys stocks and then forgets about them grossly underestimate his intelligence and investment skill. In spite of the public perception to the contrary, Buffett does sell stocks when he thinks the time is right, and it turns out he’s just as good at selling as he is at buying.
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