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.
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.
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.
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.
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.
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.
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.
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.
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?
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.