My annual richest 400 rant

I thought you could add a comment to your post about the total irrelevance of WB's method to ordinary investors. Mr. Buffett does not make his money on the markets. He takes control of companies and sets performance targets. He then uses their cash reserves for more acquisitions. This is why he buys insurance firms (which have free cash) & ignores tech stocks (most have burn only rates). Obviously this has nothing to do with trading/investing. Masses of people have been misled by all the hype claiming they can use his methods.

Warren Buffett is one individual who can make the buy and hold illusion look smart. But, let's take a look at why this strategy is dangerous to your portfolio despite Buffet's success.

I am writing this without any malice towards Mr. Buffett and I am not trying to lesser his personal achievement and the good fortune he brought to his investors.

Buy and hold only works well when prices move in your favor. The following advice is better suited to the average investor - when one is caught on the wrong end of the move – one must exit at one point and admit defeat. That is - unless one can take control over the company and control the companies’ cash. Then the consideration of common stock prices is of no importance. Sadly most of us do not have the deep pockets to do such.

What escapes most investors is the mathematics of risk reward commonly known as the edge. If the investor can maintain a risk reward ratio of 1:3 at minimum he/she will be successful in the long run. (Actually risk reward should be higher but risking $1 for every $3 made is a good minimum basis.)

What does this all mean? This explains the earlier statement concerning buy and hold drawback. When taking a position the investor should have some idea of the time frame of his investment and in reference some stop loss limit should be set. Whether mental or actual is a subject of a different article.

Andras Nagy
www.coach4traders.com




The Trading Coach

While WB does acquire whole companies from time to time, he does make investments on the stockmarket, such as his investment in Coca Cola and Gilette.

One of the fundamentals of his approach is the view that buying part of a listed company is no different to buying an unlisted company, or at least the two are not different from a valuation perspective.

You are correct in saying he can channel the cash of some companies he buys, but I don't think that means his approach is irrelevant to everyday investors.

All it means is that you need to look at both the operating characteristics and the capital management skills of the people running the companies you are investing in.

That is, if a company produces a lot of cash, you need to see what they do with that cash and whether it's a good decision. If management are making good decisions, what difference does it make if you personally channel that cash or management does what you would do anyway?

In almost all cases Buffett buys companies where management is not changed, also, so their capital management decisions usually remain unchanged.

Insurance companies, and the leverage Buffett gets by using their free float, is a different matter and certainly is different, but it's important to remember he often uses that free float to invest in non-insurance companies, and the principles used to make those investments can be applied by "ordinary" investors.

While it's true that small shareholders cannot access the cash of companies they invest in directly and immediately, this does not mean any underlying "fundamentals" are suddenly irrelevant. If a fundamental valuation strays too far prices, prices will be adjusted in the long-term. If this does not happen through individual investors moving the price, it will happen when a large investor buys up the company and efficiency is restored. Alternatively if the fundamentals and prices get completely out of whack -- for example if the company has $20 billion in cash, no debt, but is worth $10 billion on market -- shareholders can always vote to return that cash.

Regarding time frames, my approach is to look at how valuations compare to prices over time. I liek to buy things where I think the true value of a stock is higher than its current price, and sell when it corrects itself or a better opportunity arises.

The "buy and hold" approach over a long time mainly works when the value of your company is increasing over time, as happens when a company grows, and can be better than some other methods due to reduced transaction costs and taxes, which can be quite significant.

- Thomas.




http://www.thomasrice.com/