Warren Buffett is the greatest investor of all times. Many people look upon him for investment advice. Some even follow what he does as closely as possible.
Isn’t it the logical way? Do what successful people do and you will be successful too?
I would say sometimes.
To replicate success, you must ensure that you emulate the person as closely as possible.
[Free Ebook] How should you invest your first $20,000?
We asked 14 Singapore finance bloggers to share what they would do if they could go back in time and invest their first $20,000. They can no longer rewind time, but you can learn from their experience and hopefully start with a better footing.
If you take a closer look at how Warren Buffett invests, you may not be able to follow.
Here are 4 reasons why:
#1 – Buffett has access to large cash from his insurance businesses
Buffett loves the insurance business. Not only he understands it well, he is able to maximize the capital for investment.
Insurance business is often cash rich, there is free cash available after the company deduct a sum of money for compensation from the premiums paid by the clients. Insurance companies make money by investing this free cash to earn a greater return than the bonus they payout to their clients.
Being a master investor, Buffett is able to deploy this funds with great effectiveness, getting an average of 20+% returns annually.
Where does your cash come from?
Most likely, you would only have access to your savings (excluding your emergency funds), which takes time to grow.
Unless you have access to free cash like Buffett, you would not be able to multiply wealth as fast as him.
#2 – Buffett buys private business entirely and keeps the management
Unlike you, Buffett can buy businesses that are not listed in the stock exchange.
As a retail investor, do you think you can tell a private business that you want to invest in the company. Seriously, I do not think the staff would even entertain you.
As a big investor, Buffett has the cash to buy out the entire business if he thinks that it is profitable at a reasonable price. He is looking for acquisitions to keep the companies under Berkshire Hathaway as subsidiaries.
When he buys businesses, he is not interested in managing the companies. Instead, one of his criteria is to look for honest and capable managers who would continue to manage the businesses after he buys them.
And another key thing is that he gets to interact with the management directly, which gives him the opportunity to evaluate the managers.
How are you able to get close to the management as a retail investor? How do you evaluate the management before you invest? Do you see the unfair advantage?
#3 – Buffett negotiates great deals for public companies
There is a term known as PIPE – Private Investments in Public Equities. This is basically a private arrangement between a company and a big investor, where the former raises capital by offering the latter discounted stocks or debt instruments.
It can be common stocks which are sold to a discount to the current share price. It can be preferred stocks where the buyer receive a favorable dividends and the power to convert them to common stocks at a good price. It can also be warrants which work pretty much like preferred stocks.
Why would companies prefer to do this than raising capital in other methods like rights issue?
There are 2 advantages.
Firstly, the company gains by raising capital in a short time.
Secondly, it is much cheaper in terms of administration without extensive underwriting and marketing costs. Moreover, since it is private placement, the deal need not be reported to the Securities Exchange Commission (SEC).
Hence, this allows big investors like Warren Buffett to negotiate for wonderful deals to control an amount of shares in a company.
Retail investors do not have this privilege as you buy at the current price which makes market timing important – you can only get discount when the market is depressed.
#4 – Buffett invests for cashflows and not capital gains
You would have heard Buffett said he would hold stocks forever.
You have to understand his insurance businesses as well as his subsidiaries are golden geese. In other words, these businesses continue to generate healthy cash flows (golden eggs) for him.
So do you think Buffett would want to sell the geese away when they are laying golden eggs?
As a retail investor, you cannot buy the entire business. Hence, it is very difficult for you to generate significant cash flow from your limited capital.
Even for a high yielding dividend stocks, how much capital is required to receive a decent cash flow? If you invest for cash flow with limited capital, it will really take you a long time to become rich.
How should retail investors invest then?
In ‘The Intelligent Investor’, Benjamin Graham advocates an investing method that does not require all the privileges mentioned above. Instead, his investing strategy focuses on financial figures obtained from audited annual reports – data that anyone and everyone has access to.
At BigFatPurse, we have studied Benjamin Graham and Walter Schloss’s investing strategies and used their wisdom in today’s markets via our Conservative Net Asset Value (CNAV) strategy.
With these principles, we and our graduates have attained 10 – 15% annual returns. And we would like to share this strategy with you. Click here to find out more.