Monday 1 October 2012

Master of the market: Warren Buffett's secrets

The Chinese have a fascination for money. Without doubt, their greatest hero is Warren Buffett because he started out with nothing and became one of the wealthiest people in the world solely by investing on the stock market. Bill Gates is a geek but Warren Buffet is an investor.

At the China Post in Taipei, where I was employed as chief copy editor, I was regarded as the in-house expert on Warren Buffett. We had a graphic biography sent to us, which the publisher, Jack Huang asked me to review. The publisher also sent me along to a two-way satellite meeting with Peter Lynch of Fidelity Investments, who was also regarded with awe by local investors. His famous dictum was "invest in what you know."

Warren Buffett was the son of  a stockbroker who fell on hard times in the Depression. Buffett was a pupil of Benjamin Graham, the originator of value investing. Graham said Buffett was the most outstanding student he had ever had  but refused to give him a job.

Several Jewish friends of mine have asked me if Warren Buffett is Jewish. He is not Jewish. Benjamin Graham refused to give him a job because there was great discrimination against Jews and Buffett was not Jewish at a time when many Jews in the finance industry were unemployed. Graham was Jewish.

Buffett lives in Omaha, Nebraska. He is said to live in a very plain, middle class house. A friend of mine who  studied at the University of Nebraska at Omaha said they sent him an invitation every year for him to address their Commencement but he never replied. A Commencement is a rather peculiar American term for what we Australians would call a graduation ceremony. She said they went out a few times trying to find Buffet's house, but they never succeeded.

Nebraska is on the Great Plains. The entire State has a population less than half that of suburban Melbourne.  Nebraska is a treeless prairie -- very flat, prone to tornadoes and thunderstorms, very good for running cattle, producing other agricultural products and not much else. It is, however, rumored to be home to silos housing Inter Continental Ballistic Missiles (ICBMs.)

What is Warren  Buffett doing there? He's a folksy man and would fit in well. Nebraska tends to produce Republicans of the moderate sort such as Gerald Ford, who was born there. William Jennings Bryan, the Little Giant, edited the Omaha World Herald  and represented a Nebraska district in the US Congress. His "Cross of Gold" oration, advocating free coinage of silver,  to the Democratic National Convention in Chicago in 1896 is said to be the most famous speech in American political history.

Buffett has always had a profound admiration for cheap money. He discovered this early on when involved in the advertising coupon business. The money would be paid up front, which he could use as a free float. That's why he likes the insurance business. The policy holder pays his his premium, which the insurer keeps and invests until a claim is made on the policy. This is not rocket science, it's been standard practice for centuries, but it's one thing to know the theory and another to put it into practice. The Buttonwood column in the latest issue of the Economist (29 Sept. 2012) puts Warren Buffett's success down to two man factors -- leverage, and low beta stocks. The Economist estimates Buffett is leveraged by about 60% but the insurance companies have been essential at times when the market has been down and raising money has been difficult.      

The low beta theory is more interesting. High beta stocks bounce around a lot, low beta stocks don't. Just like Dame Edna's dear little New Australians, investors like colour and movement. After all, "active management" is all about beating the market average, so you need high beta stocks. Of course, when the market retreats, so do the high beta stocks. If you get a 4% management fee when the market is up but you are beating the market, your investors won't mind, but if you're still charging 4% when the market is down, they will (or should) be screaming like stuck pigs. But as Alfred E Neuman said in Mad Magazine "What? Me worry?" Of course, you can invest in Vanguard whose funds track the market. In the US Vanguard boasts "In passive we're massive" and their management fees are much lower, but that's not nearly as much fun.

Buffett has stuck to low beta stocks but as he said "it's far better to buy a wonderful company at a fair price than fair company at a wonderful price." Some stocks he has held for decades, like CocaCola. Some he has snapped up opportunistically, such as when General Electric was almost blown up by  GE Money during the global financial crisis. GE was funding its enormous loan book with short term money which dried up overnight.  Buffett did some very good deals with Goldman Sachs and San Francisco-based Wells Fargo.

It's the combination of leverage and brilliant low-beta stockpicking that's put Buffett where he is today. The man who is widely regarded as the the greatest investor of this century is worth $47 billion, making him the third richest man in the world.

Just to clear up one thing. Buffett intends to give the bulk of his fortune to his good friend and bridge buddy Bill Gates to disperse as charity. But he is a philanthropist, not an altruist. He believes that altruism and business do not mix. Good deeds don't make good business.

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