Given his cult-like following, critiquing Warren Buffett's investment approach takes a pinch of courage and a pound of stupidity. But that has never stopped me before … and it is a good time to look at Berkshire Hathaway, given that it held its annual general meeting earlier this month.
And what a stunt he pulled - just when you thought he could do no more to thrill his acolytes and expand his fan club. I'll get to that later.
Let's start with an oh-so-basic review of his secret sauce. In my mind, he has cooked up a combination of two powerful ingredients that trump all else in generating his outstanding track record: brand and concentration.
While he is busy spinning yarns about how it is better to buy a great company at a fair price than a mediocre company at a bargain price, how it is best to buy companies that can be run by monkeys because sooner or later they will be, and how investing in gold is a waste of time because it has no intrinsic value or dividend, you, me and everyone else are being "Buffettised". This is my word for any investor that becomes hypnotised through soothing, clever sayings that sound so easy to grasp and simultaneously make us smile with confidence because we know we get it. And then we repeat it to our friends.
As this repetition proceeds, the Buffett brand grows exponentially and none of us ever realised that branding was part of the equation. After all, what does branding have to do with Buffett's investment approach?
Here are a few hints: did Goldman Sachs approach you or me in the depths of the global financial crisis offering a sweet deal to "save" them? Does your banker allow you to sell short billions of put options, pocket the premiums, and put up no collateral? The list goes on. In other words, the Buffett brand gives him deal access and terms that the rest of us can only dream about.
Regarding the second key ingredient, investment concentration plays a huge role. In other words, we have been taught repeatedly by textbooks and bankers that diversification is critical to achieving attractive risk-adjusted returns. Believe me, Buffett's acquisitions of Burlington Northern and Heinz are not a play on diversification, nor are his huge positions in about 10 United States brand-name large-cap stocks.
I have been told that insurance regulators in the US allow Berkshire to hold a concentrated portfolio. That still surprises that part of my intellect that tells me concentration is a double-edged sword. In other words, we can all think of a portfolio that blew up as a result of concentrated bets. To be fair, it usually involves leverage and Buffett tends to eschew leverage.
Obviously there are many other factors to Buffett's success, and I own a small number of Berkshire shares as I too am a huge fan. But I believe the above two ingredients should be considered carefully the next time anyone is praising the food at Buffett's buffet. And regarding the stunt that I mentioned above, at the annual meeting Buffett invited a short seller in Berkshire shares to ask questions during the meeting.
On the surface this sounds fairly innocuous, but if you think about it, when was the last time you invited someone that doesn't like you to your dinner party and asked them to speak to your guests on why they don't like you or your food? Yes, it will probably take me years to get my head around this and, in the meantime, I will have another story to repeat, helping to Buffettise a few more of my friends.