A few years ago at the Berkshire Hathaway Annual Meeting, Warren Buffett said something very interesting. He said that he personally knows of a half dozen or so people who could make 50% per year managing a relatively small amount of money. I came across a reference to this comment a few days ago and I began thinking to myself: I wonder who those 6 people are?
But even though it’s interesting to consider, there are more important takeaway’s from this comment than daydreaming about who Buffett regards as the best investors… namely, how can we-as smaller investors-think in a way that allows us to achieve far greater returns?
This Buffett comment at that shareholder meeting was prompted by a previous comment (now somewhat famous) that Buffett made in a Businessweek interview in 1999:
“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
Wow! He guarantees it… and there is a good reason why he guarantees it. Because he did exactly that when he was managing around $1 million or less. He actually made about 60% per year in his early 20’s in the 1950’s prior to starting his partnership.
How To Make Big Returns
So assuming most of us manage 7-8 figures or less (or far less-it could be 5 or 6 figures… Buffett started his snowball with about $5,000), how can we take Buffett’s comments and apply them to achieve returns that far exceed the averages? We may not make 50%, but it’s interesting to note that a few of Buffett’s friends made 30% consistently managing their own small partnerships that were basically copied from Buffett. One guy worked in Buffett’s building in a completely separate business, and noticed Buffett’s eyepopping returns, and actually quit his job and started his own partnership. He’s mentioned by Buffett in his Superinvestor speech.
So how can we replicate what others, including Buffett, have done in the past and achieve returns that trounce the S&P 500?
The answer is we have to think differently. I mean differently than most investors-that’s a given. But also different than even most “value investors”. I read through many client letters and mutual fund letters of managers who call themselves value investors. There are many of them. Their language is usually filled with “Buffettisms” about buying “wonderful businesses at fair prices” and other such well-known Buffett quotes. Now, I have no issue with quotes like that, and in fact, I use plenty of my own Buffettisms on this blog and in my own company literature.
But the problem is this: many value investors buy these “wonderful” companies (and they are wonderful), but they overpay for them. This sets up these investors for mediocre returns going forward. Buying Coca-Cola was especially popular in the late 1990’s (10 years after Buffett bought it and after the stock had gone up 10-fold). There were even “value” managers who paid up for Coke, with the logic that Buffett was holding his major position and “time is the friend of the wonderful business”.
Well, Coke at 40 times earnings is not that wonderful. And time is the friend of the great business, but in that example, it took over a decade to work off the excess value, leaving Coke shareholders with little to no real returns for a long time. Coke is an extreme example, but many value managers end up hugging the S&P 500 because they aren’t thinking opportunistically enough.
Now, I follow Buffett more than I do any other investor, so it’s crucial to understand that I’m just challenging you to think like Buffett in the 1950’s, not like Buffett in the 2000’s. We can learn a tremendous amount from Buffett in the 2000’s, but we should take note of how he achieved those 50% returns (hint… it wasn’t by buying and holding great businesses-at least not at first… it was by buying extremely undervalued stocks, selling them as they reached fair value, and repeating the process over and over… a Graham like approach with Buffett like concentration).
To Sum it Up
I’m going through screens this morning looking for undervalued stocks in the sea of the fairly to slightly overvalued overall market. One thing that helps me as I go through my screens is this simple question: How can I make money? I’m not sure if this makes sense, but for me, it helps me to think of stocks as individual investments, rather than worrying about an overall strategy or the overall market environment. Just ask yourself: Which stock can I invest in that will make me a lot of money?
I think Buffett likely thought of stocks this way when he was making 60% a year in the early 1950’s, and 30% a year while running his partnership. He didn’t care really what the overall market was doing, as long as he could find stocks that were undervalued that presented him with low risk ways to make a lot of money.
Think like this… bottom up, not top down. Don’t worry about markets or the economy, just search for undervalued stocks.