What Warren Buffett Is Telling Us To Do Now

| March 11, 2009 | 0 Comments

Growing up in Nebraska, I’ve witnessed Warren Buffett’s impact firsthand. The oracle is revered in the state for the amount of money he’s made for investors.  However, why he hasn’t blessed our beloved Husker football program with an endowment (ala T. Boone Pickens and Oklahoma State University) is still a mystery.  But I digress.

I enjoyed studying Mr. Buffett as a finance undergrad at the University of Nebraska.  Luckily, I was able to attend a Berkshire Hathaway annual shareholder meeting back in the mid 90’s.

You could feel the energy buzzing inside Aksarben’s large auditorium. People hang on every word, trying to read between the lines.  Everyone’s hoping for one nugget, one secret capable of sending them to rock star investor status.

But that’s not the way it works.  It’s not a single event or practice that makes a great investor.  It’s a combination of discipline and a willingness to face reality that makes Buffett so successful.

Even though I know there’s no magic formula guaranteed to make people billionaires, Buffett’s insights in Berkshire’s Annual Report are as close as it gets.  This year I took two important things from the report.

First, the fact that the financial meltdown is intentionally being caused by the CEOs of the large financial firms currently being bailed out.  And second is why now is the time to be buying stocks.

To begin with, all of the executives of the financial institutions accepting TARP funds should be shot.  Ok, shooting them is bit much but at least they should be fired.  Let me clarify that, fire all senior management of financial institutions who developed massive portfolios of derivatives.

Here’s a quick rundown on derivatives.  They’re assets that derive their value from something else, thus the name derivative.  They’re complex financial assets.  But the kicker is they’re so complex nobody knows how to value them.  Beyond that it gives me a headache trying to explain them.  What’s important is they’re a major cause of the current financial implosion.

Mr. Buffett explained the situation in his typical ‘pull no punches’ fashion but with a bit a humor.

“Participants [in derivative markets] seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease:  It’s not just whom you sleep with, but also whom they are sleeping with.”

And the reality is the institutions didn’t know who their trading partners were “sleeping with”.

There are only two possible scenarios as to why management would allow these ‘paper assets’ on their books.  They either didn’t understand the risks or didn’t care.  Both of which are inexcusable.

Mr. Buffett seems to think, and I agree, it was the latter.  CEOs completely disregarded risk in the name of short term profits and fat bonuses.

And that’s downright scary considering the size of the companies we’re dealing with.

CEOs willingly and knowingly put the future of our country in jeopardy. Intentionally creating a mess so large that when the whole thing blew up the government would have no choice but to step in.

In my book their actions border on financial terrorism.  And last I checked we’re still in the business of stamping out terrorist activities.  Maybe we should consider bringing back water boarding…

I believe moving forward as an economy and as a country we must discard the culture that created the mess.  And the only way to do it is by banishing the Senior Managers who created these Frankenstein companies.
Let the companies fail and the chips fall where they may.  New companies will grow out of the ashes, trust me.

It’s called capitalism and it’s worked before.

Now that I’ve got that off my chest (I’m feeling pretty liberated right now), let me tell you about the big insight that could put big profits in your pocket.

A word of caution though; this isn’t for the faint of heart.

As Buffett says: “When investing, pessimism is your friend, euphoria the enemy.”  If there’s any euphoria left in this market it’s surely drug-induced.  The overload of pessimism means right now is the time to start buying equities.

Not just any equities, underpriced equities.

Mr. Buffett’s demonstrated that value investing works best with simple companies.  The ones producing tangible products and services essential to everyday life.  The best part is, well managed companies fulfilling these requirements are subject to mis-valuations in the market.

This gives value investors capable of shaking off fear the best buying opportunity in decades.

You might be asking, “How can the entire market mis-value stocks?”  It comes down to how much risk investors are willing to tolerate.  And according to Buffet, “The investment world has gone from underpricing risk to overpricing it.”

Here’s a way to think about it:  When risk is overpriced, equities are underpriced.

According to Buffett, now is the time to be a buyer.  Which leads us to the next question.  What’s the best way to get back into equities?

Start by identifying positions you want to hold for the long run.  Dip your toe in and continue to build positions over time.  Take advantage of sell-offs as opportunities to buy at bigger discounts.  If new information becomes available, don’t be afraid to dump a position at a loss to conserve capital.

Now if your stock analysis skills aren’t up to par with Buffett, ETFs may be a good choice.  Certain ETFs focus on value stocks.  They provide a great way to get in on the action without all the heavy lifting.  One in particular I like right now is the iShares Russell 1000 Value Index Fund (IWD).  This ETF gives you a piece of 646 large cap value stocks.

Currently you’ll see this ETF is down, way down.  But in the mind of a value investor, this is a good buy… a huge discount to the true value it will return over the long run.

The Warren Buffett way should once again return big profits.  I believe value investing should perform better than the rest of the market in coming years.  If it does, IWD should outperform the broad market indexes.

As you can tell, I’ve developed a deep respect for Mr. Buffett’s opinions and judgment over the years.  I take some comfort in his disgust with the financial institutions that jeopardized our country.

Whatever the end game is, it shouldn’t impact the effectiveness of a value investing strategy started today.  Buffett’s value strategy is often difficult to imitate in a bull market.  But a good bear market provides value investors a great opportunity to follow his lead.

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Category: Stocks

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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