Five lessons from Buffett’s latest deal

Published on 2015/08/18

This is Warren Buffett’s largest ever single investment: For $37.2 billion he has bought Precision Castparts Corp (PCC), a company that supplies parts to the aerospace industry, including Boeing and Airbus, as well as to numerous energy companies. What can we conclude from this deal?

  1. The first lesson: Concentration, not diversification. In one fell swoop, Buffett is investing more than half of Berkshire Hathaway’s accumulated cash reserves. Diversification makes sense for those with limited investment experience. Such investors are well advised, even according to Warren Buffet, to invest in an ETF index fund. Of course, that will never lead to untold riches. “Diversification is protection against ignorance. It makes little sense if you know what you are doing,” as Buffet once famously said. Also: When you understand the ins-and-outs of an investment vehicle – real estate, for example – you can forget widely accepted advice such as, “Don’t place all your eggs in one basket.” You can also ignore Harry M. Markowitz’s famous Portfolio Theory. It is concentration that leads to riches, not diversification. If you are firmly committed to an investment, you can turn concentration risk into tremendous opportunity.
  2. The second lesson: View crises as opportunities! Forget what other people say, such as, “The trend is your friend,” or, “never touch a falling knife.” These stock market wisdoms may well apply to stock traders with a short-term investment strategy – but not to long-term investors. PCC’s stock price had lost a third of its value since June 2014. Falling oil and gas prices had caused a number of customers to delay planned investments. “When you get a chance to buy a wonderful company you know there is usually some reason why you are getting that chance and perhaps the slump in oil and gas helps us in this case,” was one of Buffet’s comments on his mega-deal. Many anti-cyclical investors have been wondering how to turn recent drops in oil and gas prices into profits. The best approach rarely involves a direct investment (e.g. buying oil futures); there is more potential in indirect investments – in this case from buying a company whose prospects are indirectly linked to the development of oil and gas prices. “Cash combined with courage in a crisis is priceless”, is, after all, Buffett’s credo.
  3. The third lesson: Be patient and take a long-term view. Buffett spent a long time sitting on three per cent of PCC’s stocks. When the time was right and sentiment towards the company was at its most negative, Buffet seized his chance in big style. This is typical Buffet: He gets to know a company and bides his time, sometimes for years, before he takes advantage of low prices, caused by a stock exchange crash, for example, to make his move.
  4. The fourth lesson: Don’t trust the analysts. UBS shifted its assessment of PCC’s stocks from “neutral” to “buy” in January 2013, entirely wide of the mark. Their timing was dreadful, coming just as PCC’s stocks started their long decline. RBS Capital revised its valuation of the stocks at the end of October 2014, admittedly saving some face with a minimal downgrade from “top pick” to “outperform”. Just last month, JP Morgan gave the share a “neutral” rating. “Hold” is the rating PCC’s stocks have received from an overwhelming majority of analysts over recent months. Given the convoluted and deliberately opaque language typically used by analysts, in most cases “hold” actually means “sell.”
  5. The fifth lesson: Investment opportunities will always present themselves, even in an investment climate like the current one, when pretty much every asset class – stocks, bonds, real estate, etc. – is highly over-priced.

These five basic principles may sound simple – but who really lives and acts by them? Living according to these principles requires just as much know-how as courage: concentration, not diversification; swimming against the mainstream tide; not being unsettled by analysts’ commentaries; and having the patience to play the long game. This is how Buffet became a rich man.

Read more about these tenets for successful investment in my recently published book, “Reich werden und bleiben” (“Become rich and stay rich”).

About the Author

Dr. Rainer Zitelmann is one of the leading experts for the strategic positioning and communications of companies.