You Can't Invest Like Buffett

There's no question that Warren Buffett is one of the most successful investors of all time. But can individual investors replicate his success?

A common view of how Buffett invests is that he finds a business that is undervalued by the market, buys a portion of it (or the entire thing), and waits until the market correctly values or even overvalues the business, or simply collects the cash it spits out, which he uses to buy other businesses.

It seems like anyone can do this. All one needs to do is to learn how to value companies correctly enough to know when their shares are selling at a deep discount.

What this rosy picture leaves out is the many times it was necessary for one of Buffett's proxies or Buffett himself to get involved directly in the invested company's management in order to make a profit, or even salvage the investment.

Sanborn Map

The Sanborn Map Company attracted Warren Buffett's avaricious attention because it held an investment portfolio that was worth more than Sanborn Map's market capitalization. That is, its assets were worth more than its stock price. It also had a profitable business of selling very detailed maps to insurance companies.

The company was trading below its liquidation value, even though it had a monopoly on the fire insurance map business, because insurance companies were gradually doing away with using maps for their underwriting.

This was a perfect "cigar butt" of a stock, good for one last profitable puff and with a big margin of safety. Any investor could see that while Sanborn Map's business was declining, the company was worth much more than the market was valuing it. So, any investor could have bought the shares and made a bunch of money, right? Not really.

The value Buffett saw in the company was locked. A regular investor could buy the stock, but he had no way to unlock that value.

Buffett, on the other hand, had enough money (a substantial portion of his investment partnership's portfolio) to buy enough shares and ally himself with other shareholders to control around 40% of the Sanborn stock. He was able to leverage this control to make Sanborn's management spinoff the company's investment portfolio. Only then was Buffett able to make a profit.

In other words, Buffett had to get a controlling share of Sanborn's stock through using his clients' funds and by negotiating with others to force management to do his bidding to realize any gains. Simply finding and buying a piece of an undervalued business was not enough.

Solomon Brothers

Buffett invested in Solomon Brothers with a big margin of safety. All that had to happen for him to cash in was the investment bank staying in business. Then, a Solomon bond trader, on a few occasions, submitted false bids at Treasury auctions to get around auction rules, corner the market, and make a profit by squeezing short sellers. Upper management covered up this illegal activity.

When the fraudulent trades were revealed, the only reason the company didn't go out of business was because Buffett assumed the Chairman position and basically groveled to government regulators not to let Solomon fail.

As with Sanborn Map, a regular investor wouldn't be able to go this extra mile (or marathon) to save his investment. And no margin of safety would be big enough to lower the risk.

Berkshire Hathaway's Many Insurance Companies

One of the keys to Buffett's (Berkshire Hathaway's) success is his investing the float from cash generating businesses in more cash generating businesses, and to repeat the process over and over. (One of Buffett's earliest implementations of this idea was with pinball machines. The cash generated by the first pinball machine was used to buy a second. Then the cash generated by the first two pinball machines was used to buy a third, and so on.)

That's why Buffett bought so many insurance companies over the years. However, pretty much every insurance company that he bought got into trouble almost immediately. General Re is the biggest and possibly the most famous one (it lost billions of dollars), but most of Buffett's insurance businesses suffered losses as soon as he purchased them. That he bought them below their intrinsic worth proved an insufficient margin of safety.

A regular investor in these companies would have the choice of selling the stock or waiting it out in hopes of a turnaround. Thus, a regular investor would lose most or all of his money by either selling at a loss or holding the stock until the company went bankrupt.

But Buffett, in having bought the companies outright, was able to direct changes, assign capable people, etc to salvage the businesses and make successes out of failure.

The Buffalo News

Buffalo NY was a two newspaper town and Buffett decided to buy one of them. The Buffalo News made its money with a weekday edition, while its competitor made most of its money with the Sunday edition. Buffett bought the Buffalo News with a plan to put out a Sunday edition.

Chaos ensued.

The Buffalo News became embroiled in a lawsuit, where the judge prevented the paper from advertising its new Sunday edition. There were also labor strikes. The paper lost millions of dollars, despite one of Buffett's proxies doing his best to trim the excess fat off of the company's operations.

A regular investor wouldn't be able to weather this storm. Indeed, even Buffett wanted to quit. But his partner Charlie Munger prevailed. Eventually, an appellate court ruled in Buffett's favor. Only then did the investment become profitable.

Coca-Cola

Even when Buffett didn't own the entire company, or a controlling share, he was still able to enact change. For example, Berkshire Hathaway bought billions of dollars of Coca-Cola stock, and the investment did very well (partly due to accounting trickery). When CEO Roberto Goizueta died and was replaced by his protege Douglas Ivester, who did not do as good a job as his predecessor (because the accounting tricks were not sustainable), KO stock took a nose dive.

As in the cases above, a regular investor could either sell or hold on in the hopes of a turnaround. Buffett had another option. Although he didn't have a controlling stake in Coca-Cola, he was able to get together with another board member and have a secret conversation with Ivester. Soon thereafter, Ivester resigned from his position as CEO.

Many other examples could be listed, but the point is that even when one follows Buffett's investment philosophy perfectly (like Buffett did), that in no way ensures success. Often times, a much more active approach is needed. Indeed, in many of his more profitable investments, Buffett resembled Carl Icahn a lot more than Warren Buffett the passive investor. And being Carl Icahn is a lot more different and more difficult than being a passive investor.