How Warren Buffett is Different from Most Investors, Part 1

There was an academic article published recently on the investing of Warren Buffett.  Afterward, I thought I saw a few articles reflecting on it, but here is the only one I see now: There’s Warren Buffett — and then there’s the rest of us.

Buffett is different, because he grew as an investor and as a businessman, and usually made the right moves over a 50+ year career.  When you don’t have a lot of assets, and few people are doing value investing, you can do amazing things with special situations, and being an activist investor.  In 1967, Buffett had control of a textile company named Berkshire Hathaway, when he used the resources of the company to purchase some smallish P&C insurance companies, National Indemnity and National Fire and Marine Insurance.

This brings up the first way that Buffett is different than most investors.  He understands and invests in a complex industry, P&C insurance.  He begins to realize that it can be used as a platform for greater investing.  As he sees that potential, he buys half of GEICO in the 70s, before buying the whole company in 1994.

This brings up the second way that Buffett is different than most investors: Buffett was willing to buy whole companies, not replace management for the most part, and operate them.  Buffett limited himself to being the wholly-owned company’s board, asking questions on management competence, and redirecting free cash flow for the greater good of Berkshire Hathaway.

That brings me to the third way in which Buffett is different than most investors: He analyzes cash flow streams from investments, and buys shares in companies, or the whole company when they offer a reliable high prospective free cash flow yield.  And it brings me to the fourth way Warren Buffett is different than most investors: Buffett does not diversify, particularly in the early years.  He plays for best advantage.  Buffett views investing through the lens of compounding cash flows, and does not pay much attention to the market as a whole.

In my opinion, it is a worthy use of time (but don’t neglect your family) to read through the annual letters of Berkshire Hathaway.  If you do that, you will get a sense of a clever businessman who would invest for best advantage.  His tactics shifted over time, but he was always looking to compound free cash flows at the best possible rate.

I’m going to hit the publish button now, but I will finish this in part 2.

5 Comments

  • Conscience of a Conservative says:

    The Warren Buffett of the 1970’s , 1980’s and perhaps even the 1990’s is very different than the investor we see today. Today he often makes his money or doesn’t in complex derivatives, investing in solar projects(Topaz in Southern California) that are only economic due to gov’t credits, or lending money to investors on sweet heart terms where his willingness to do so and information on the situation is the result of conversations with political leaders and insiders(Bank America). The days where he poured over balance sheets and purchased on a Graham Dodd derived analysis are long gone.

  • brmr_pal says:

    Mr. Merkel,
    Been a longtime reader of your blog. My first comment here. ( more like a question about what i understood about buffet)

    As i’ve been through his letters and other material ( bio, investments e.t.c) I’ve realized some of what you’ve said here a few years ago . I just want to make sure that I understood it properly.

    Here is what i’ve observed, He differed from graham’s net net and arbitrage plays and went into special situations taking control of companies ( dempster mill- activist investor) expanded his tolls by including Philip Fisher’s techniques as well in early 60’s. Though he held more concentrated positions that Graham.

    Once he bought Berkshire and then National Indemnity he has started using that float- (this also provided him leverage and including) It’s where he changed his approach. It was also advantageous as he has more permanent capital unlike hedge funds as he has seen the redemption’s Munger had when he had down years ( about 38% drawdown i think).
    He did private equity kind of deals ( Not like LBO’s) but taking control for cheap valuations and sprucing them up, the uproar in the mid-west on his efforts in acquiring a company ( compared to vultures) before he cultivated this well crafted media friendly personality.
    Intially he concentrated more on midcap & small cap companies. It when competition is low and he was ahead of his time in creating a structure that hput few limitations on how he’s allowed to deploy capital. It’s much harder now days for a hedgefund as competition has increased and they do not have access to cashflows the same way.
    So in short he had leverage, access to cash flows which approximates annuity structure ( as they are recurring where as hedgefunds has only divindends and has to sell stock to get cash to deploy in another investment) which provided further fuel to his investment acumen though this is by design of his structuring the company.

  • Greg says:

    You forgot to mention the biggest difference with Buffett: he doesn’t have to obey the same laws as the rest of us.

    Solomon Bros treasury rigging, Coca-Cola’s accounting “irregularities”, GenRe’s derivative nonsense, FNMA’s accounting irregularities, and even though the Obama media dropped the story after Buffett supported tax hikes — we have to remember the Sokol insider trading scandal of which Buffett was directly involved.

    Normal investors would have faced ruinous regulatory investigations, lawsuits and penalties.

    Buffett got a free pass because he is a political crony. His daddy was a congressman (far more honest than Warren) and Buffett has played his father’s connections to the max.

    Buffett got special treatment from the SEC on reporting his holdings. Supposedly this was a “one off” exception, but it was renewed for years. Most investors can’t get any exceptions, no one but Buffett gets the exceptions renewed over and over.

    Buffett also received enormous taxpayer bailout monies via his Wells Fargo, Goldman Sachs and GE scams. Its easy to “beat the market” when Bernanke gives GS and GE money at zero percent, then GS and GE give the same money to Warren plus 10% dividends. Backdoor bailouts are not evidence of investing prowess, it is evidence of political cronyism.

    Its pretty easy for anyone to match Buffett’s returns — if we got the same bailouts and special rules that he gets.

    Shame on you David Merkel. What ever happened to the commandment not to worship false idols? Buffett is not a god, he is a political crony with a PR team to prove it.

    That is why Ben Graham REJECTED Warren Buffett for employment all those years ago.

  • microcap says:

    Greg– I am not a Buffett fan at all but David provides a balanced commentary on him compared to most. You can disagree with him but the personal snark is inappropriate and unwarranted.

    Unlike 99% of investment blogs, David’s remains valuable in its detail and refusal to devolve into diatribes either in his posts or in the comments. You make some legitimate points, stick to those.

    • Greg says:

      MicroCap – I agree that David provides a great service to us all with his blog. Most of his posts are balanced and his disclosure of his investment process thinking is an invaluable learning tool for himself and the public.

      I firmly believe that if David got taxpayer bailouts and special legal treatment from political bureaucrats (as Warren Buffet gets) — Merkel’s investment performance would be much BETTER than Berkshire’s.

      Any investor could “beat the market” if they got bailed out on their worst trades and never faced any legal consequences for breaking securities law.

      Worshiping Buffett like he is a great investor is an insult to anyone trying to learn honest investing tools.

      Graham invented value investing. Buffett copied Graham’s tools, and used political cronyism to tilt the table in his own favor. That is the special sauce Buffett uses. Nothing else.

      Why should an actual investor (such as David) look up to a political hack?

      Picking a mentor in the financial industry is 1000x more difficult than most fields. As a general rule though, anyone who’s name is in the media, as Buffett’s is, is almost certainly over-hyped.

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