Q&A: Evaluating Stocks Out Of Buffett’s Portfolio vs S&P500?

Reader Question: In March of this year I sold off my stock portfolio, and bought stocks from Buffett’s portfolio and am up.  Is the improvement just average (due to the rise in the market) or due to the selection of stocks?

Related Article: Warren Buffet (Berkshire Hathaway) Stock Portfolio – Update 2009 Q2

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How can you compare if the performance increase of the stocks purchased out of Buffett’s portfolio is just due to the rise in the market?  One way is to compare the price gain percentage from when stocks were purchased (we’ll pick March 25th).  The S&P500 index was 989.67 yesterday and 813.88 on March 25th. Its gain was 21.6%.  Now  compare the percentage from the stocks purchased out of Buffett’s portfolio.  If the percentage is greater it is above average (market average). Keep in mind that purchasing an S&P500 ETF (index fund) will not give 21.6% due to management fees etc (even though they are pretty low). I would like to mention however, that overall such a comparison is not a very valuable activity. I will discuss why, later in the article.

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Now I will say this with caution, but “coat tail riding” (as he would put it) of Buffett’s moves and selections, would probably allow an individual investor to reap returns that are above average over the long term.  But what will an individual do when he is no longer around? Unfortunately, he is approaching that age.  My solution is to heed his advice, and that is to learn what he knows, and how he is able to do so well.  So far it has worked very well (especially during downturns) for both stock and non-stock related investments.

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Something to keep in mind is that the short term unrealized price gain performance we were comparing could easily have been the other way around, with the S&P500 performing better than the selection from Buffett’s portfolio. Such a comparison is not a good way to judge performance, as Buffett usually reminds us.  But this is the method that Wall Street uses, and shows the masses.  Do we care if we beat the S&P500?  For example, is it good if we are able to lose only 5% when the S&P loses 10%?  No, because you still lost money.  Absolute return is what matters!  Evaluating performance based absolute returns, and not relative to the index makes more sense.  The index / market comparison is only useful for comparing purchasing the market (ETF) over selecting individual stocks.

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The method of short term evaluation of price performance on any arbitrary day is what Wall Street has drilled into everyone.  It does not capture price performance when the stocks reach or go above their intrinsic values (whenever that happens to be).  Investments are not likely to be sold all at the same time, or on any random day either. Doing so would be the same as throwing a dart on the calendar to determine the day to sell.  With investments, each investment should be evaluated individually.  For stocks especially, each stock represents a different company with individual business performances tied to milestones, incomes, growth rates, problems, customers, etc.  So the time when business performance starts to more accurately be reflected in their stock prices, will occur at different points in time.

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Unrealized gains on the entire portfolio should be evaluated based on year over year returns over a period of many years.  The returns on the portfolio should be compounding as the years progress.

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Riding Buffett’s coat tails in this manner presents other issues.  How will you know the intrinsic value has been fully realized in the stock price for a particular company and may signal an opportunity to sell at full value?  Buffett’s stock moves are only made public months after they have been made.  The SEC allows Berkshire to delay filing this information to avoid the public from blindly copying Buffett’s actions, partly to allow the company to keep their competitive advantage but also to prevent the public from getting into things they do not really know.  His reasons for making specific purchases, at specific prices, may never really be known to the public.  Nor would the public really be able to know what he intends to do with it (exit strategy).  Remember, his actions are based on the long term strategy for Berkshire Hathaway, not an individual investor.  For example his very long term derivative contracts on the four indexes, may be too long for an individual investor a few years away from retirement.

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A better way of riding on Buffett’s investment moves are to buy shares of Berkshire Hathaway directly.  This way you are reaping benefits of his strategy and plans directly.  Year over year performance of Berkshire Hathaway is very impressive, over the past few decades.  Personally, I have invested in Berkshire Hathaway stock.  But I also have invested in other stocks, some of which Berkshire coincidentally holds as well.  However, on stocks that overlap with Berkshire’s holdings, many things are different.  My purchases prices in many cases were below Berkshire’s (I like a larger margin of safety) and at different points in time.   I hold them for different reasons, with different exit strategies, and different calculated intrinsic values.  I don’t know Berkshire’s reasons for holding them, their exit strategy, or what Buffett calculated the intrinsic values to be.   In other words, my investment decisions are made based on my investment plan, strategy, needs, and what my research and analysis tells me, not by his investment moves.

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Coat tail riding as a method of searching for investment ideas may be good, but not deciding which investments to actually purchase.  Individual investors still need to do their own due diligence and homework, as well as assessing whether it fits into their own overall plan.

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Feel free to post questions, comments, or topic suggestions.

Don’t forget to rate the article!

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Thanks & Happy Investing!

The Investment Blogger © 2009

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Related Books:

The Intelligent Investor (Benjamin Graham)
Amazon.com Amazon.ca Chapters.ca
[Amazon.com version includes preface by Warren Buffett]

Securities Analysis: 6th Edition (Benjamin Graham)
Amazon.com Chapters.ca
[Not available at Amazon.ca ] [Chapters only has classic edition]

The Snowball: Warren Buffett & The Business of Life (by Alice Schroeder)
Amazon.com Amazon.ca Chapters.ca

The Warren Buffett Way (Robert G. Hagstrom)
Amazon.com Amazon.ca Chapters.ca

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