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Some Warren Buffett Investing Rules – Part 2

March 6, 2014

Continued from my previous blog…

Emotional Involvement

We are all emotional and many investment decisions are made based on emotions and not just the facts.  His advantage is that he makes fewer emotional investment decisions than most of us.  Yes, he does make some emotional decisions – he is human!  He also leans toward companies that make products he understands.

Heinz Deal

An example of the type of deal Buffett can do that most cannot is the acquisition of H.J. Heinz.  BRK and a Brazilian partner, 3G, each invested $4.4 billion for equal 50% interests.  BRK then invested $8 billion in preferred stock paying a 9% dividend.  Therefore, BRK will receive, off the top, $720 million before either equity owner receives a cent of the profits.  There is also debt financing from JP Morgan and Wells Fargo and assumption of present Company debt making the entire deal worth $28 billion.  3G are the owners of Anheuser Busch and are proven very capable managers of consumer products businesses so Buffett got a great partner (for very low cost) to oversee his investment.

Aversion to Loss

Buffett doesn’t like to lose and would rather pass on a deal than go into something without underlying value.  If the value is there, the stock might not increase so quickly, but the way he sees it, downside is limited.  He buys stocks that he feels will have low volatility, low risk, low leverage, that are safe, cheap, profitable, high quality and growing payout ratios.  Strong brand recognition and possibly a secret process or patent or unique product is also a plus.  He also looks for management with strong ethical values and that look to maximize shareholder value.  Look at definition of value investing above.

Leverage Risks

Leverage is another way of defining debt.  Many investors trade on margin in that they borrow against the stocks they own to buy more stocks.  Doing this accelerates gains, but also accelerates losses.  Also, interest payments are a drag on profits which must exceed the interest paid.  Further, momentary drops in the stock the broker holds as collateral can cause the stock to be sold ending the ability to recover from those drops.  Buffett does not use significant borrowed money to acquire his shares.

Plan an Investment Plan

Buffett has a well-disciplined plan, investing values, goals and criteria that he rarely deviates from.  He also has the discipline to wait and not chase overpriced companies, often looking to acquire stock at what he sees as large discounts from his assessment of the Company’s “fair value.”


With a lone exception, BRK has never paid a dividend accumulating and compounding its earnings and investing in more and more situations.  He also uses his cash hoard to rebuy some BRK stock when he believes BRK’s market value is too low.  On some level, if he did not control BRK, it would not be a stock Buffett would invest in because it doesn’t pay any dividends.  He created a company in the image and style that suits him and his personality.

Buy When Others Sell

When the market tanks, more people are selling than buying.  The drop in stock prices has nothing to do with the intrinsic value of the company, and Buffett looks at this as a buying opportunity.  Let’s face it, when you go to buy a car, do you secretly wish the price was higher?  Well, people buy stocks after they’ve increased in price and hold off on their purchases when the price drops.  Not Buffett.

Market Timing

Many people think they can time the market by frequent trading.  Buffett is a “buy and hold” investor.  He doesn’t believe in market timing as a strategy.

Investors’ Trading Costs

Individual investors have many costs of trading that reduce their returns.  Brokerage commissions, the spread between bid and ask prices when trades are executed, taxes, operating and management costs of mutual funds or managed accounts and courses and subscriptions to investor publications and news services.  Additionally, there is time opportunity cost where an investor spends time learning about trading and stock situations and analyzing and trading his portfolio.  Warren Buffett does what he is doing as part of making his living and individual nonprofessional investors cannot come close to the time he spends.  Also, his trades, as for most institutional investors, are at a reduced “wholesale” cost.

Outsmarting Everyone Else

Most investors, and virtually all traders, are trying to outsmart every other person like themselves with similar thoughts that think they found a gem among the weeds.  For every buy transaction, there is a seller that thinks the opposite.  They cannot both be right.

Warren Buffett is Warren Buffett

Many times Buffett can make a better deal for himself than others can get is because of the value created by people knowing he invested in that deal.  When the market was crashing the end of 2008 and beginning of 2009, knowing that Buffett was investing in certain companies created a reassurance to the markets.  It also propped up the market and some people got back some confidence.

3 Comments leave one →
  1. March 6, 2014 1:45 pm

    I know you mentioned tax efficiency in Part 1, but few know just how shrewd a tax man Warren really is. Right from the start Warren got the joke about delaying / avoiding tax. One of Berkshire’s first purchases in 1967 was a company called National Indemnity Corp., a sleepy little insurance company. That first insurance company acquisition was later followed by GenRe and GEICO. Insurance companies have a special tax benefit that no other taxpayer has … a deduction for reserves. This makes an insurance company a very tax efficient investment vehicle. And, if you think about it, an insurance company is at some level just an investment company (or hedge fund) that also writes insurance in some limited amount. People yell about giant hedge fund managers who are now creating offshore reinsurance companies to run their money more tax efficiently but it was Warren that started the whole game.

    • March 6, 2014 10:13 pm

      Thanks Tony. You’re my hedge fund / insurance company go-to person.

  2. Robert Nagler permalink
    March 6, 2014 7:29 pm


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