You Can Invest Like Warren Buffett

I want to be very clear: You CAN invest like Warren Buffett.

I recently read an incredibly ridiculous, misleading, self-serving article that argued the complete opposite.

It would be one thing if it were on someone's personal blog or part of some crackhead rant on the Yahoo stock market message boards.

But, of course, it was published by the mainstream media (ABC News, in fact) and supports my contention that the managed money industry will say or do anything to discourage individuals from investing on their own (so they can continue collecting fees from everyone who buys into this notion that individuals have no business managing their own investments).

Please don't read any political subtext into my swipe at ABC News or my reference to the "mainstream media."

My beef with media companies like ABC, USA Today, CNN, Money Magazine, etc. isn't ideological. It's that when it comes to financial or business reporting, everything is so dumbed down as to be nearly useless.

In fact, I would contend that it only exists as fodder around which the managed money industry can then deliver their ads and marketing campaigns.

Misconstruing Buffett's Success

The article, in my not so humble opinion, is a collection of one asinine statement after another (I wouldn't refer to them as points since, by definition, they would actually need to be true in order to qualify for that designation).

So let's wade into the morass and some of the more egregious assertions . . .

Asinine Statement #1

"Millions of investors, mesmerized by this man who has become a legend in his own time, seek to follow in his investing footsteps. They fall deeper into a trance of idol worship with Buffett's every pithy comment. Dreaming of riches to come, they buy whatever Buffett does."

WRONG - Millions of investors? Seriously? There simply AREN'T millions of investors in the first place. There may be millions of 401K savers who are forced to dump their hard earned retirement savings into that quintessential substandard "investment" vehicle, the mutual fund.

If long term investing is a journey to a successful retirement, then using mutual funds to get there is like booking passage in steerage.

It's been amply documented - every year, most fund managers underperform the market.

On the whole, they overtrade, have way too much money to competently manage, conduct end of quarter "window dressing," and, in my opinion, are much more concerned about keeping their jobs in the short term than they are about building wealth for their clients over the long term.

As far as the author's portrayal of those who seek to emulate Warren Buffett's investing philosophy as drooling cult members, it's pretty hard to take him very seriously.

"Dreaming of riches to come, they buy whatever Buffett does."

Another mischaracterization. Buffett's philosophy is amazingly simple, consistent, amply documented, and is comprised of four core components - (1) paying as little as possible to (2) own quality businesses over the (3) very long term, and then (4) reinvesting the earnings in order to further compound the returns.

That's not exactly a recipe for attracting the get rich quick crowd.

Asinine Statement #2

"Buffett, Berkshire's chairman and CEO, makes all the investment decisions for the company and its subsidiaries. His mind-boggling wealth comes not from his own personal portfolio, but from his ownership stake in Berkshire Hathaway."

WRONG - Well, duh! Of course his mind-boggling wealth comes from his ownership stake in Berkshire. Who has ever suggested otherwise?

The author seems to be cynically playing the "Buffett has all the unfair advantages and you have none" card.

If he had any intention whatsoever of legitimately helping others to build long term wealth, he would explain HOW Buffett came into the position of his ownership stake in Berkshire Hathaway in the first place.

Berkshire-Hathaway, on an operational basis, was a New England textile operation in a deteriorating industry (but which was still cash flow positive and priced very cheaply) that Buffett and a group of core investors purchased outright following the dissolution of a previous investment partnership.

Buffett was much like a small, early hedge fund manager in that he was compensated by receiving a portion of his partnerships' (which were all later rolled into one partnership) total returns. That's how he built up a core ownership in Berkshire after most everything else in the partnership was liquidated.

Buffett then used the cash flow from Berkshire and other early investments in insurance companies to make additional investments in other high cash flow businesses.

It was a process that just continued to compound on itself - invest in great, high cash flow companies at attractive prices for the long term and reinvest.

That's too complicated or difficult for the individual investor to replicate? Or is it more a case that the fee based managed money industry must resort to mischaracterization and misinformation to keep most people in the dark?

Asinine Statement #3

"Investing for a cash-rich corporation puts Buffett in an extremely unusual, if not unique, position because it enables him to weather market storms that the rest of us can't. This gives him an advantage not only over individual investors but also over professional portfolio managers who, to keep clients, must produce returns for them year in, year out or investors may bail. Because of these demands, they can't take the hits that Buffett can."

WRONG - Says who? Yes, Berkshire is a "cash-rich" corporation. But that's because Buffett has always invested (and reinvested) IN cash-rich corporations. And there's absolutely nothing that prevents any individual investor from doing the same exact thing.

I do agree with the part about portfolio (and fund) managers being under performance pressures from fickle clients who WILL bail during market downturns (although the part about how they "must produce returns for them year in, year out" is pretty laughable - if only that were true - although, to be fair, the author didn't explicitly specify that those returns had to be positive).

Followers of Buffett (and Graham) - you know, those idol worshippers locked in their zombie-like trances - understand that true investing is actual ownership. And actual ownership entitles you to your share of the company's profits generated from the operations of the underlying business.

They aren't concerned about market declines because their long term wealth and near term yield has nothing to do with fluctuating market prices.

The share price of a stock represents only one of two things:

the potential purchase price of a new investment, or
the potential liquidation price of an existing one

And long term, Buffett-style investors simply aren't going to bail on a quality company just because the artificial net worth of the stock market as a whole is heading lower.

In fact, your best defense against a bear market is actually owning individual high quality companies, and loading up on them the more they fall.

Remember when the world was ending back in late 2008, early 2009? It may have felt like that for those with low quality, diversified portfolios (I guess I'm being a little redundant there since I consider "low quality" and "diversified" to be largely synonymous).

But long term investors in world class businesses like Coca-Cola, McDonald's, Procter & Gamble, Johnson & Johnson, Hershey's, McCormick & Company, General Mills, and so on barely noticed. Not only did their income not drop, but each one of these companies continued RAISING their dividends in the face of the Great Recession.

And the really smart ones used those proceeds to buy even more shares in these and other high quality companies.

Some of these opportunities were truly once in a generation gifts - such as Starbucks which actually closed one day at $7.98/share back in March of 2009. Three years later it was trading in the low to mid $50s, and had not only initiated a dividend, but had actually raised in a couple of times so that three years later, it would be equivalent to a nearly 10% yield for those who purchased shares at the 2009 low.

Even a purchase at $10/share would be equivalent to a 7.8% annual effective dividend yield in less than 3 years.

So why can't the individual invest on his or her own in high quality, consistently profitable, high cash flow businesses at attractive prices and then simply allow the underlying operations and the power of compounding work?

Is the managed money industry suggesting that the laws and principles of mathematics are simply going to cease working if we have the audacity to employ them?

Asinine Statement #4

"Understanding the differences between investing for a corporate conglomerate and doing so for yourself can keep you from losing your shirt trying to be Buffett."

WRONG - Sure . . . You're ALWAYS hearing about investors losing their entire life savings in crazy high risk investments in companies like Coca-Cola, Kraft, and Wal-Mart.

Wow - I'm sorry, but the author's statement above is just amazingly stupid. Buffett is arguably the most successful investor who ever lived. His investing model and philosophy clearly work. And yet the author would have you believe that emulating Buffett is somehow risky and reckless.

Asinine Statement #5

"Your time horizon for investing isn't infinite. Someday, you'll be investing less because you'll stop bringing home a paycheck and will be drawing from your portfolio to pay for living expenses during retirement. In planning for this, the goal is to build up assets and manage them well so you don't outlive your wealth."

WRONG WRONG WRONG!!! - Without a doubt, this is the biggest and most pervasive lie that those who seek to "manage" your investments for a set fee schedule have foisted onto the public.

In order for them to live in their gated communities, you have to be persuaded that your only choice to not be destitute during your golden years is to work your @$$ off for someone else for forty years, gradually amassing a large enough account value (which most likely won't be compounding all that well during those forty years) so that you can finally retire and begin depleting that lifetime of savings.

Further, the model that they have successfully convinced most of us is the only sane way to invest, the idea is that you begin liquidating a set amount of your portfolio each year, and then hoping you die before it eventually runs out.

That's what the phrase, outlive your wealth, really means. And if you're in a position where you're hoping that you don't outlive your wealth? Well that's a pretty good indication that you DON'T have wealth.

And under their model, if you live long enough, your money WILL run out. In the good market years, your portfolio may actually grow, increasing in value by more than the amount you've sold off to eat. But then there are the bad years, when the market will be down 10%, 15%, 20% or more.

This is what I refer to as the Net Worth Trap and why it's so crucial that you understand that an ever increasing cash flow, and not a perpetually shrinking net worth, is what's going to determine the quality of your future and the future of those you leave behind.

Warren Buffett has an unfair advantage because Berkshire Hathaway will outlive him? Again, that's the point - your investments SHOULD outlive you.

Really, what the managed money industry has successfully been doing for years is nothing more that an elaborate sleight of hand trick. They have so convinced us to focus on net worth, net worth, net worth.

But it isn't net worth that pays the bills - it's income and cash flow.

And if you do invest like Warren Buffett - investing in quality, high cash flow businesses, with consistent earnings, and long track records of paying rising dividends, then you WILL compound EVERY year, regardless of where the Dow or the S&P 500 trades.

You'll compound your income.

Here's the bottom line - the older I get, the more my income increases, and I'm NEVER forced to liquidate my ownership in a world class business just to keep the lights on.

And when I die, I'll die at my highest income level and have something of real value to pass on to the next generation.

Asinine Statement #6

"Buffett's lack of a time horizon allows him to dollar-cost average for immortal time periods. Dollar-cost averaging is periodically buying a fixed dollar amount of a stock on a regular schedule, thus getting more shares when the price is low and lowering the average price of shares accumulated. Without a time horizon, Buffett can do this indefinitely. But if you do it too long, your portfolio may not have time to recover from purchasing shares at a high price."

WRONG - I'm sorry, but there's just no way around it - the author is really being a complete @$$hole. Buffett has NEVER dollar cost averaged and he's well known for his extraordinary investing patience, willing to sit on huge stockpiles of cash for years at a time before deploying it in quality businesses and opportunities at prices he deems attractive.

This begs the question - why would a financial professional even make such a statement?

I truly don't know. Personally, I've never been able to reliably distinguish people with dastardly agendas from people who are simply incompetent.

My natural inclination is to assume the former since we're talking about a professional, but I've been surprised before at the power and reach of incompetence among "professionals" and "experts."

Translation: Never blindly acquiesce to someone else's judgment or interpretation of reality just because you assume they're an "expert" and know what they're doing.

Secondary Translation: I'm an individual investor, not a professional money manager, and I don't consider myself an "expert." But I have been successful in a few areas of my life, and I do possess, in my opinion, a pretty reliable bullshit detector.

Asinine Statement #7

"Your source of investment capital is your salary. Once you retire, you won't have this capital. If you take a pay cut or lose your job before retiring, the effect is the same: You'll have less - or no - investment capital. Meanwhile, Berkshire's investment capital is virtually infinite."

WRONG - As I addressed earlier, if you buy into the managed money industry's treadmill model of substandard investment performance (for you) and recurring fee income (for them), then, yes, you will find yourself held hostage to the paycheck to paycheck life.

But I absolutely 100% believe this: You CAN do better. You CAN learn to adopt the same sound fundamental investing principles that Buffett personally used to amass his own fortune. You CAN choose to take ownership over your own investments and your own life, and yes, you CAN invest like Warren Buffett if you so choose.

You can also learn more about what I believe the reasons are for Buffett's success here.

Asinine Statement #8

"Often it is Buffett's reputation that assures success. He has become an activist investor, and in times of crisis he exerts the power of his brand as a measure of value. Stocks sometimes rise immediately merely because he buys them. Buffett can go to public companies and negotiate the purchase of shares at prices unavailable to us mortals."

WARNING: EVIL, DASTARDLY, VILLAINOUS BEHAVIOR EXPOSED AHEAD! - And here the author is - you guessed it - wrong once again. Sure, there are often temporary spikes in shares of a stock when SEC filings disclose Buffett has been acquiring those shares, but those are short-lived, day to day price fluctuations that have no impact whatsoever on the performance of Berkshire's long term investments.

"Buffett can go to public companies and negotiate the purchase of shares at prices unavailable to us mortals."

OK, here's where I take back my earlier indecisiveness. This sentence is constructed in such a way that it's very clear (to me, in my own personal opinion, of course) the author falls into the "dastardly agenda" category.

And he also shows his contempt for the readers of his article - he words his sentence in such a way that it's not technically a lie, and yet he still attempts to leave you with an impression that's not consistent with the truth.

He's referring to three financial crisis era deals involving preferred shares, not common shares, in GE, Goldman Sachs, and Bank of America (although the Bank of America deal took place a little later).

Preferred shares are more like debt than equity - they're priced at a certain par value (which they will eventually be redeemed at) and don't offer the opportunity for capital appreciation in the way that common shares do. But they do, in general, offer higher yielding dividends.

Buffett's annual yield on the preferreds were 6% on BAC and 10% each on GE and GS.

He also received warrants in each of these deals to purchase a sizable number of common shares at a future date for a certain price (at or above what was then the current share price of these equities, I believe).

Those were all multi-billion dollar transactions that provided some very large corporations some serious infusions of cash (and a vote of confidence) that they needed. It's true, you and I weren't in on these deals because we didn't have tens of billions of dollars laying around.

But come on - 10% yields? 6% yields? And what were, in effect, at the money and out of the money call options? These are amazing, back room, sweetheart deals?

Predictably, the author neglects to specify the terms of any of these deals, but instead relies on insinuation and trusting that the reader will fill in the blanks with stereotypical images of sinister titans of industry controlling the world.

The warrants could actually turn out to be pretty lucrative, depending on where the share prices end up before the warrants expire.

But it's telling that the managed money industry has so conditioned us to believe that even a 10% annual return represents stellar, outsized gains.

As I mentioned earlier, if you'd bought SBUX when the professional money managers were all dumping it as fast as they could, you would've been up 500% in 3 years, and you'd be getting an annual dividend somewhere between 8-10%, which is only going to continue to rise in the future.

But could it be possible that the author chose his words so carefully because, as a representative of the managed money industry, it's in his best interest that you have an inaccurate view of reality?

Because he wants you to believe that Buffett is sneaking around and paying substantially less to buy common shares and entire companies than you or I ever could?

This simply couldn't be further from the truth. In fact, Buffett has often pointed out that Berkshire has grown so large that the only deals that it makes sense for him to contemplate are very large deals, such as the outright purchase of the Burlington Northern Railroad.

Smaller deals with much higher ROI potential are off the table for him because they would have virtually no impact on the overall Berkshire investment portfolio. Buffett himself has even floated the idea that if he had a smaller portfolio, such as $1 million or less, that he could compound at 50% a year.

The author also knows this - when Company A purchases Company B outright (when it "negotiates the purchase of shares") it negotiates the purchase of ALL the outstanding shares, and for a premium.

So when Buffett bought Burlington Northern back in 2009, he actually paid a 31.5% premium to acquire the company.

Further, in some of his early shareholder letters, such as Buffett's 1981 Berkshire Shareholder Letter, back when Berkshire was a whole lot smaller, Buffett made the point that buying partial stakes in high quality companies with shares trading at attractive prices (at what he considered a discount) made a whole lot more sense than acquiring entire companies and paying a premium to do so.

So contrary to the author's disingenuous assertion that Buffett's investing size assures him of outperforming smaller, individual investors, the reality is that the smaller investor actually has a substantial structural advantage over Buffett.

Asinine Statement #9

"Buffett is widely regarded as the greatest value investor of our time. Value investing is the practice of buying stocks that are currently out of favor with the market with an expectation that they will rise in value."

WRONG - That may be a generic definition of value investing, but it does not accurately sum up Buffett's approach.

The Warren Buffett and Charlie Munger value investing approach can best be summed up by one of Buffett's famous quotes: "It's far better to by a wonderful business at a fair price than it is to buy a fair business at a wonderful price."

And why is that?

It goes back to the reality that investing is ownership. As a passive owner of a high quality business, you are compensated, not by timing the market or churning your portfolio or chasing momentum stocks, but by the earnings produced from the underlying operations of the business itself.

Why is that such a radical concept? Why has the managed money industry so muddied the waters that the average person doesn't even know what investing even means?

If you were allowed to own, privately and totally, just one publicly traded company in the world, which one would you choose? If you and your family's future depended solely on the earnings produced by one company, which one would you choose?

If I were to ask a thousand people that question, I'm sure there would be many different answers, but I bet there would be a common denominator, too - quality.

I doubt you'd find many struggling retailers or declining business models on the list. I wouldn't expect companies like Sears Holdings, H&R Block, or Radio Shack on the list.

Never forget - investing is owning the business, not the price of the stock.

Don't Let Others Tell You What You Can't Do

I generally try to keep my website and public comments positive and civil. The internet already has enough vileness and viciousness as it is.

But when I read articles like this that are so patently false and so transparent in their objective to disempower everyone they come into contact with, it really makes my blood boil.

I don't care whether we're talking about your finances or any other area of your life, you must guard against the siren call from those who tell you to scale back, take it easy, don't try so hard, don't think for yourself, to choose comfort over greatness.

And while they soothe you, encourage you to lower your expectations and postpone your dreams just a little longer, they'll only bleed you a little bit, just close your eyes and relax, you've had a long day, you won't even notice . . .

But, of course, all those soothing reassurances that mediocrity is the norm masks a more sinister, disempowering message that drones on and on - you're not smart enough, you're not sophisticated enough, you're not worthy enough to be successful.

And you swallow that poison at your own peril . . .

How I Invest Like Warren Buffett

I owe a great deal of my own success to adopting Warren Buffett's 4 core principles (attempting to buy great companies at attractive prices and reinvesting for the long term).

But I'm far from the caricature presented by the author of the above article - there are a number of companies that Buffett owns, for example, that I would never be interested in owning myself (as a former customer of Wells Fargo, I don't share Buffett's enthusiasm for its business model, for instance).

But I go about employing those core investing principles in my own unique way.

My primary difference is that I use conservative option trading as a way to capitalize on that most elusive of the 4 core factors - price.

Let's face it - the opportunity to buy Starbucks @ $7.98/share doesn't come around very often . . . unless you learn some alternative way to lower the cost basis on your holdings.

And that's exactly what I use options to do - I employ certain conservative option strategies before, during, and after I acquire shares in high quality businesses.

That option income has a couple of important and related functions:

It becomes a source of additional investing funds
It can be seen as a sort of rebate or cost basis reduction on your existing stock investments

Using Options to Invest Like Warren Buffett

I call my approach Leveraged Investing (the leverage comes not from debt, but from the conservative option trades).

Options-oriented value investing really has changed my life, and I've put together this site to share my experiences, journey, and resources with other like-minded individuals.

But I'm not so arrogant or self-serving as to suggest that my way is the only way to build wealth in the stock market. Or that any other choice you make will lead to ruin.

I don't know whether my approach, experiences, and resources will match your personality and help you reach your own objectives - only you can decide that.

But, regardless, if you haven't already, I do strongly urge you to find a self-directed investing approach (stock market or otherwise) that works for you and matches your own psychology - because the more areas of your life that you take direct ownership over, the greater your life becomes.

And the more easily you'll recognize that mass-broadcast call for human surrender for what it really is.

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