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Financial Literacy

Why You Should Not Invest Like Warren Buffet

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Why You Should Not Invest Like Warren Buffet

 

Warren Buffet is one of the richest men in the world and is also one of the most talked about, respected and followed investor in the world.

READ: Get familiar with Bill Gates and Warren Buffet’s favourite business book 

Warren Buffet, unlike many other investors has a style of investing that is quite unique to him and has proven to be successful for over 3 decades. Investors in Warren Buffet’s Berkshire Hathaway have seen the value of their investments grow exponentially over the years through a style referred to as Value Investing. Through value investing, Warren Buffet ignores the short-term nature of technical analysis, relying on the business model, corporate governance and competitive edge a company has to invest in it for the long-term. This process is called fundamental analysis and differs from technical analysis which relies on past information about the share price movement of a stock by using charts and other statistical analytic tools to predict the future price of a stock. Fundamental analysis includes a comprehensive understanding of the business, its risk profile, competition, capital structure and most importantly what Warren Buffet calls an economic Moat.

READ: Why Warren Buffett’s company is buying shares of a gold mining company

Warren Buffet is one of the most respected investors in the world. However, trying to emulate him as a retail investor can lead you to huge financial losses if you do not understand what makes him different. There are several reasons why you cannot invest Like Warren Buffet.

READ: Gold prices surge by 17.4% in 2 months due to global economic crisis

Pool of Funds – Unlike retail investors who mostly use their funds to invest, Warren Buffet doesn’t only use his own money to invest. When Warren Buffet started investing in the 60’s he pooled money from wealthy working class Americans that he knew at the time to form a sort of mutual fund. That fund went on to buy companies that even made him more money that he could use to broaden his investments. One of his major cash generating machines is an insurance company called Geico. Warren Buffet collects the money paid as premium for insurance and invests it in business that help it make even more money, Warren Buffet, recognized the power of cash flow (see below) and as such started by pulling together a good cash balance that helped him apply his value investing techniques. For a retail investor who is investing his own funds, it is foolhardy to believe that you can buy very good companies that will provide you cash flow to buy other companies. For example, a company that pays Warren Buffet 10% on a $1 billion (N200 billion) investment earns him $100 million (N20 billion). This is starkly different from 10% on N1 million which gives you N100,000 annually.

READ: U.S biggest listed companies post best monthly gains since January 1987

Cash flow – Warren Buffet and his Berkshire Hathaway investment company is said to have over $60 billion in cash to invest into companies. To put it into better perspective, Nigerian had under $28 billion in foreign exchange reserve as at the end of April 2016. With that sort of cash, Warren Buffet can cherry pick companies that he wishes to invest in. They can also use that cash hoard to buy into more cash generating companies that will even help to yield more cash (Geico as explained above). When he also buys companies, he buys significant proportion that can either give him a sit at the board or significant shareholdings that will give him a say in how the business is run. Retail investors hardly have more than N5 million annually to invest at any one time. Unlike, Warren Buffet you do not have a similar cash position and surely can’t buy significant portions of businesses as he does. This means, target companies don’t even know that you exist or that you are even their shareholder. You have no way of influencing their operations.

READ: PayPal, Square make top 10 list of most valuable U.S banks

Bargains – We talked about Warren Buffet’s Cash flow. One thing cash flow does for you is that it gives you the ability to get deals at a bargain price. At the height of the financial crisis in 2009, Warren Buffet was given an offer by Goldman Sachs (one of the world’s biggest investment bank) to buy $5 billion worth of shares in exchange for a 10% dividend yield and a warrant to buy another $5 billion worth of equities at a price of $110. This was during the financial crisis in 2008 when Lehman Brothers (another leading investment bank) had just collapsed. In 2013, Warren Buffet exercised his rights at bought $2 billion worth of Goldman Sachs. At the time Goldman Sachs was trading at $158 thus giving his company a profit spread of $43 per share. Not everyone can get this sort of deals and I don’t see any retail investor who can ever get one. Bargains prices can be gotten during block buys from the Nigerian stock exchange but only institutional investors can get such deals because of their financial muscle. Retail investors cannot get such deals.

READ: Why Warren Buffett is making less money now

Significant Purchases – Value investing requires that you purchase shares in companies that have very sound fundamentals. However, because companies are run by human beings it is likely that, it is likely that it will one day be run by a poor management team. Warren Buffet understands this which is why he once said, he like to buy companies with business models that are so good, they can be run by a stupid person because someday a stupid person will run it. Warren Buffet makes sure a stupid person does not remain in that company for much longer by buying a large stake that gives him a say on how the business is run. If things get so bad he can also sell down his share which managers of the business dread.  In addition, Warren Buffet can also purchase significant portions in very well run companies giving him an opportunity to benefit even more. In Nigeria, retail investors can only purchase as much as their portfolio allows them to even when they see a company that has incredible value. Your purchases may not be significant enough to give you maximum returns.

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READ: How Cash flow, Liquidity, and Leverage impacts your financial plans

Resources – Unlike you, Warren Buffet has a vast pool of professionals who are paid to help him analyze financial statements and businesses of companies that they own as well as prospecting businesses. These guys spend all their time sifting through countless financial statements looking for businesses that they can buy or sell. As a retail investor, you probably have a regular job while jostling through other time-consuming activities. There is not enough time to properly analyze investments the way Warren Buffet and his team would.

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READ: Nigerian retail industry can’t grow without proper franchise system – CIG boss

Income Model – To Warren Buffet, his major way of getting a return on his investments is via dividends. He likes to buy companies that have a long-term record of dividend payments and will most likely continue to pay him dividends for as long as he is invested in such companies. He hardly sells his shares in the company’s that he owns. For a retail investor looking to copy this model, you have to ask yourself if it is really worth it considering the amount you invested. Going back to the cash example, if you invest N1 million in a company that pays your N100,000 dividend yearly would you prefer it to taken a more risky approach of investing in a company that can appreciate by 10% within a month?

READ: CAP Plc is running at a risk of increased bad debts

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Shareholder Power – In America, retail investors are better protected via strict rules and regulations that help ensue financial transparency. Nigeria is just getting there as most quoted companies still see them sell has political institutions rather than as financial institutions with a responsibility to be transparent and accountable to shareholders. Without shareholder power or activism it is difficult for a retail investor in Nigeria to highlight poor corporate governance within quoted companies. This makes investing long-term in companies extremely difficult. As a small time shareholder, you can own shares in your company and never earn a dividend. Even when you decide to sell and take a loss, you might not see a single buyer for your shares. You are basically at the whims and caprices of the managers of the company. All Warren Buffet needs to do is just to utter a word of resentment.

US Economy – Unlike the Nigerian economy, the US economy is the world’s biggest and most competitive economies. For example, the economy of a state like California in the US is about 4 times that of Nigeria. Due to its size and sophistication the American economy is built to be resilient to global economic meltdowns which can lead to a contagion. Even when the US economy goes through a major recession like it did in between 2009 and 2011, they have the resources and the ability to turn it around. Nigeria on the other hand is fully dependent on the global economy to survive. With oil being our single largest income earner, a drop in the price of oil and indeed other commodity prices will negatively impact on the economy. For investors who wish to invest long like Warren Buffet, it is tough to hold your investment on the long-term in a world of boom and bust cycles, where the economy boons for three years and them bust for another three.

Finally, to be as successful as Warren Buffet it is important that retail investors understanding the leverage he has. Whilst a lot of his techniques and virtues can be imbibed, it is important to recognize your limits as a retail investor and why you can’t possibly invest like him. Your risk appetite as a retail investor must be more aggressive than Warren Buffet if you wish to be successful.

 

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Nairametrics is Nigeria's top business news and financial analysis website. We focus on providing resources that help small businesses and retail investors make better investing decisions. Nairametrics is updated daily by a team of professionals. Post updated as "Nairametrics" are published by our Editorial Board.

2 Comments

2 Comments

  1. Bola Oyebo

    May 1, 2016 at 6:41 pm

    Excellent analysis!

    My challenge with value investing in Nigeria is reliance on Financial Reporting solely on annual reports can be misleading. Intelligence from “grape vines” sometimes tell a different story of the true state of affairs. It makes you question the role of auditors in these reports.

  2. Legend

    May 1, 2016 at 10:53 pm

    Buffet is the son of the Fed. I like him anyway.

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Personal Finance

5C’s of creditworthiness: What lenders, Investors look for in a business plan

Business owners need to be aware of the criteria lenders and investors use when evaluating the creditworthiness of entrepreneurs seeking financing.

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Five things to consider before securing a loan

Banks usually are not a new venture’s sole source of capital because a bank’s return is limited by the interest rate it negotiates, but its risk could be the entire amount of the loan if the new business fails. Once a business is operational and has an established financial track record, banks become a regular source of financing.

For this reason, the small business owner needs to be aware of the criteria lenders and investors use when evaluating the creditworthiness of entrepreneurs seeking financing.

Will the business that an entrepreneur actually creates look exactly like the company described in the business plan? Of course, not.

The real value in preparing a business plan is not so much in the finished document itself but in the process it goes through – a process in which the entrepreneur learns how to compete successfully in the marketplace. In addition, a solid plan is essential to raising the capital needed to start a business; lenders and investors demand it.

Lenders and investors refer to these criteria as the five C’s of credit.

READ: 5 ways to raise funding for your business

1. Capital: A small business must have a stable income base before any lender is willing to grant a loan. Otherwise, the lender would not be making, in effect, a capital investment in the business. Most banks refuse to make loans that are capital investment because the potential for return on the investment is limited strictly on the interest on the loan, and the potential loss would probably exceed the reward. In addition, the most common reasons that banks give for rejecting small business loan applications are undercapitalization or too much debt. Banks expect a small company to have an equity base investment by the owner(s) that will help support the venture during times of financial strain, which are common during the start-up and growth phases of a business. Lenders and investors see capital as a risk-sharing strategy with entrepreneurs.

2. Capacity: A synonym for capital is cash flow. Lenders and investors must be convinced of the firm’s ability to meet its regular financial obligation and to repay loans, and that takes cash. More small businesses fail from lack of cash than from lack of profit. It is possible for a company to be showing a profit and still have no cash – that is, to be bankrupt. Lenders expect small businesses to pass the test of liquidity, especially for short term loans. Potential lenders and investors examine closely a small company’s cash flow position to decide whether it has the capacity necessary to survive until it can sustain itself.

READ: How to scale as a small business on a budget

3. Collateral: Collateral includes any asset an entrepreneur pledges to a lender as security for repayment of a loan. If the company defaults on a loan, the lender has the right to sell the collateral and use the proceeds to satisfy the loan. Typically, banks make much unsecured loans (those not backed up by collateral) to business start-ups. Bankers view the entrepreneurs’ willingness to pledge collateral (personal or business assets) as an indication of their dedication to making the venture a success. A sound business plan can improve a banker’s attitude towards venture.

4. Character: Before extending a loan or making an investment in a small business, lenders and investors must be satisfied with an entrepreneur’s character. The evaluation of character frequently is based on intangible factors such as honesty, integrity, competence, polish, determination, intelligence, and ability. Although the qualities judged are abstract, this evaluation plays a critical role in the decision to put money into a business or not.

READ: 7 Ways to pay for your higher education

5. Conditions: The conditions surrounding a funding request also affects an entrepreneur’s chances of receiving financing. Lenders and investors consider factors relating to a business’ operation such as potential growth in the market, competition, location, strength, weakness, opportunities and threats. Another important condition influencing the banks is the shape of the overall economy, including interest rate levels, inflation rate, and demand for money. Although these factors are beyond an entrepreneur’s control, they still are an important component in a banker’s decision.

The higher a smaller business scores on the five C’s, the greater its chances of receiving a loan.

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Written by Chukwuma Aguwa

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Personal Finance

Don’t be fooled by COVID-related scams

Always consult the institution in charge of health-related matters to confirm any fishy information you come across.

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The nature of and the manifestation of the Covid-19 disease is such that there’s only a little time available to remedy the situation before it gets chronic. Although the infection begins by exhibiting mild symptoms, if you do nothing in a short time, it could lead to death in a matter of days.

This whole picture has caused many to become desperate about Covid-related issues, launching into panic mode at the sight of any information. As a result, such people are not far away from falling for fraudsters.

With the different kinds of news flying around, you mustn’t be fooled by Covid-related scams.

The Coronavirus threatens the health of millions of people around the world daily, also killing thousands along the way. To curb the spread and remedy the situation, bodies like the CDC, WHO, and every country’s local health organisation like the NCDC, frequently circulate information around communities. However, it has also led to fraudsters taking advantage to provide fake news, and even asking for donations.

Each day, there seems to be a new account or NGO asking for donations into the health sector, and though some are legit, many are just fraudsters posing to take advantage of innocent citizens. So far, numerous complaints about scams have been recorded, especially with people who are looking to support the health cause in any way they can.

READ: Africa to spend $9 billion on Covid-19 vaccine, access to supply is big problem

Channels used for COVID-related scams 

There are three major ways scammers take advantage of the haziness of the situation to dupe people. To start with, they appeal to the emotions of humans, who see the high death toll and suffering. As a result of what is happening, people have been willing to donate funds for medical supplies, isolation centres, and financial compensation for medical workers.

Scammers take advantage of this by posing as charity organisations and solicit for funds. Most times, as soon as their target is met, they clear their footprint without leaving a trace behind.

Another way they scam people is by manufacturing and selling fake or low-quality health products. Everyone wants to get their hands on a cure, or something that can at least protect them from the virus, and scammers are meeting their needs by providing just that.

READ: China joins WHO vaccine programme as it fills huge gap left by United States

The World Health Organization currently approves only one vaccine, and any other thing outside it is outrightly fake or just a supplement that will help your body. Currently, only the Pfizer vaccine is clinically tested and approved to work. Be sure to not throw your money in the wind by purchasing some of these fake drugs around.

Lastly, scammers create systems to extract a patient’s personal information, thereby having access to the person’s true identity. It could be in the simple form of opening a registration portal where you supply all your details.

Therefore, only give information to approved bodies and not any random online site that appears legit. These fraudulent individuals can do a lot of damage to your identity. Stay vigilant, only communicate with approved bodies, and always ask questions if you are not sure or suspect foul play.

The place of electronics in COVID-related scams

These fraudsters usually reach out to you through the digital sphere. Hence, watch out for cold calls, text messages, or emails requesting donations to certain bodies. The best way to confirm the legitimacy of such a message is to visit the organisation’s official website in a different browser. Never follow the link in the mail or text directly, as it can be easily embedded with spyware. Therefore, a single click could see them extract all your personal information, including bank details.

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Also, please stay away from those who claim to have a cure, and accompany it with testimonies of people who have used it. They are low graders desperate for your money. Vet them by searching online and see what people are saying. In all, always look out for suspicious messages, and opt out if you are sceptical.

In a nutshell, you should not believe any cure, vaccine or supplement that the World Health Organization does not approve of.

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Conclusion

The government or legit health institutions do not cold call citizens to request donations or coerce them into making one. If you receive a call out of the blues, chances are it’s a scam, which is why they mostly try to hurry you to donate before you realise it. Always consult the institution in charge of health-related matters to confirm any fishy information you come across.

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