Following Buffett Blindly Can Be Injurious To Your Wealth

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Following Buffett Blindly Can Be Injurious To Your WealthThe Oracle had spoken. “I’m impressed with the profit generating abilities of the franchise”, Buffett said of Bank of America.

“This is a vote of confidence by a savvy investor”, touted Bank of America’s chairman.

Buffett followed up with an investment of $5 billion in the beleaguered bank. Nervous investors heard what they needed to hear and followed the pied piper in hordes. The bank’s depressed shares, soared by 10%.

Two of my favorite quotes from Warren Buffett:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

“I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”

Is Bank of America truly a wonderful company?

This is not the first time Buffett is bailing out companies. GE and Goldman Sachs too were recipients of his stamp of approval. The stories are in fact, quite similar.

Buffett’s investment in Goldman Sachs

After the collapse of Lehman Brothers in September of 2008, the once invincible Goldman Sachs looked vulnerable and its stock was taking a pounding. Fear and uncertainty was everywhere and investor confidence was at its lowest.

Within a week after the collapse, a deal with the devil was struck.

  • Buffet will infuse $5 billion in Goldman Sachs as preferred shares carrying a 10% annual dividend
  • Buffett will retain rights to buy additional $5 billion worth of Goldman Sachs shares anytime within 5 years at $115 a piece, at 9% lower than GS’ closing price that day
  • A penalty of 10% if Goldman Sachs decides to buy back the preferred shares

The aftermath:

The $5 billion investment of Buffett returned Berkshire Hathaway $6.5 billion in just 3 years! Goldman Sachs realized with a 10% dividend, Buffett was making out like a bandit. In March this year, Goldman Sachs did what Buffett knew all along, bought out the preferred shares after paying the 10% penalty terminating the deal.

The devil in this deal turned out to be Buffett.

What of the GS investors who followed Buffett?

The deal was announced on September 23, 2008. Assuming a ‘savvy’ investor had bought Goldman Sachs shares on September 24, 2008 at $133.00 (closing price), the investor will be sitting at an unrealized loss of 16.5% today.

Buffett hasn’t exercised his right to buy Goldman Sachs’ common shares at $115. GS is trading at $111 as of this post.

Buffett’s bailout of GE

GE has a similar tale to tell. In 2008, GE’s finance arm was threatening the rest of GE. GE couldn’t maintain its own earnings estimates. By October, it’s shares were down more than 40%. At it’s lowest ebb, Buffett once again, made his move.

  • Buffett agreed to invest $3 billion in GE as preferred stock carrying a 10% annual dividend
  • The shares can be repurchased after 3 years at a 10% premium
  • Buffett reserves the right to purchase additional $3 billion worth of GE common shares anytime within the next 5 years at a fixed price of $22.25.

The aftermath:

GE literally had to pay a steep price with the 10% payout. Berkshire Hathaway earned a sweet $900 million just in dividends. GE plans to buyback the shares this fall after paying the 10% premium.

What of the GE investors who followed Buffett?

Let’s see. The announcement was made in October 1, 2008. If an investor had purchased GE shares the next day, which at that time was trading at $22.15, he would be sitting at an unrealized loss of 29.8% today!

What to make of Buffett and his Bank of America endorsement?

I do not think Buffett truly believes Bank of America is a wonderful company. There seems to be no end in sight to BofA’s woes. The lawsuits keep coming and analysts still don’t know the extent of BofA’s frauds.

Buffett is an opportunist. The deal like the ones before, is cleverly structured and heavily in Buffett’s favor.

  • Buffett’s investment will get him preferred shares of BofA carrying a 6% annual dividend
  • Buffett also gets to buy an additional $5 billion worth of BofA shares at a fixed price of $7.14 anytime in the next 10 years!

An individual investor is not in the same boat as Mr. Buffett. It is hard to predict in which direction BofA’s stock price will swing, but either way, Buffett will make money, not so for the individual investor who follows Buffett blindly. Those who followed Buffett with GS and GE are still licking their wounds and both, in my opinion, are healthier than BofA.

Am I investing in BofA? No, but I’m investing in Berkshire Hathaway!

Disclosure: Long BRK.B

37 thoughts on “Following Buffett Blindly Can Be Injurious To Your Wealth

  1. I’d argue there’s a big different between a Buffett common stock purchase and a preferred stock purchase. The preferred stock purchase is more about collecting a dividend for a certain period of time than an outright endorsement of quality of the underlying business and its management.

    Ken Lewis, former CEO of BAC, made a big mistake acquiring countrywide mortgage and he overpaid for every acquisition he ever made. Common shareholders will be paying the price for that for a while. However, if BAC can overcome its short to intermediate term problems it is worth more than 6 bucks a share.

    • Sure BoL. But, the soaring stock prices reflect that investors think this is their cue to buy BofA. This may or may not benefit them, but will definitely benefit Buffett especially if the stock prices go above $7.14!

      • Within 5 years, I’d bet BAC common stock is in the mid 20s once they get the lawsuits behind them and the housing market improves, and Buffet will profit handsomely on both the preferred and common when he exercises that option. BAC isn’t going belly up. Buffett has negotiated excellent terms for himself and Berkshire. Even if he never exercises his stock options, he will still earn a healthy profit off of the preferred.

        • Precisely! Buffett has negotiated a good deal. Investors who think they can ride his coattails may or may not do so well.

          I’m not questioning what Buffett did, but I’d be wary of blindly following him when the deal is not the same for the individual investor.

  2. If the European financial crisis expands, then this willleave BofA as the most leverage/exposed bank in America. This could put WB’s position in jeopardy. We’ll see how it plays out.

    • Buffett will make money no matter how BofA does, not so investors following Buffett if things turn sour for the bank.

  3. Buffet’s got a great thing going right now. He is his own brand and companies will “pay” him with these lucrative deals just to get his name associated with their stock. He does face the risk of the company going bankrupt, but it seems to have paid off so far. Since an individual investor doesn’t get anything vaguely like what he gets, there is zero reason for any of us to follow him.

    • Since he’s bought preferred shares, even in a bankruptcy, he’s ahead of the line. His risk is actually very minimal! As you say, he is putting his brand to good, profitable use!

  4. I’m glad to hear that simply copying what Buffett does isn’t the best advice. Regardless, I don’t intend to put any money into BoA stocks where I can help it. I like your point at the end about investing in Berkshire Hathaway :)

  5. You are right, it is not good to follow Buffett. It is better to be Buffett and pull off these kinds of deals.

  6. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”—Warren Buffett

    A quote that’s easy enough to understand, yet so true and sensible!

    Let’s just continue to take track and vigilant about the BofA and be wise in our decisions for us not to loose control.

  7. Money can’t buy happiness, but it sure seems to buy power…. I still can’t believe all of the “legal scams” that caused the recent down economy and NO ONE went to jail…. legal crimes…. They get away with it and middle class America suffers deeply from it! :(

  8. If because of this the stock prices of BAC raises I will be happy, I can get rid of the shares I have of them.

  9. Wow I hadn’t seen the actual terms of the deals he made with them before. Those are some high returns! Investing in BH definitely sounds like the way to go. -Sydney

  10. Hey MoneyCone, really great post man! I’ll have to do a weekly roundup now just to include this one post :)

    Oh bashing the Oracle, OMG that could be viewed as controversial. But your absolutely correct. It’s a great deal for Buffett, has nothing to with company fundamentals, and investors jump on board without even realizing why they are (except for the swing traders making a nice profit). Other than that, BAC has just as good fundamentals as the Irish and some other European banks.

    Nice post!

  11. Excellent analysis as always. It is hard for me to be unbiased about Bank of America because I once was a managing director of one of their investment subsidiaries and saw first hand how they operated. As you point out they have been involved in a big way in every single fraud that Wall Street has carried out over the years.

    From another direction I saw them sell subsidiaries for unbelievable amounts and tell the employees that built the value in the companies “screw you” here’s your pittance severance pay “don’t let the door hit you an the way out.”

    They made an agreement with me and my partner and then reneged. They literally told us that they had an army of lawyers with nothing to do and they loved to litigate employment contracts if we didn’t mind spending a good portion of our life traveling and giving depositions. I decided I would rather jump into a pit of vipers than to spend my time fighting them.

    I am sort of a fan of Buffet’s but I cannot understand why he deals with the likes of these people. He reputation is solid – is he that mercenary? I understand his shareholders love it.

    My question is why is Bank of America so desperate for capital that they would offer these terms?

    Maybe one of these days, hopefully in my lifetime, the Feds aren’t going to bailout Bank of America.

  12. Buffett sure is an opportunist, no doubt. I read a book on him (one of many, I’m sure), which detaled his history. The guy seems quite principled, in an opportunitic way. This is par for the course.

    Absolutely, Buffett and an individual investor aren’t in the same boat. I have to admit that I find his success quite fascinating though.

  13. Nice post MC! I was wondering about Buffett’s other deals. He made out like a bandit and common folks got take for a ride. They don’t call him the Oracle for nothing!

  14. There are plenty of reasons to admire Buffett, but this isn’t one of them. I could not stomach investing like Buffett in this instance!

  15. Great article here. I was talking to a co-worker just the other day about this move by Buffett. I completely agree with your last assertion of him being an opportunist. In an uncertain market (and world, for that matter), he’s receiving a certain 6% on his money, with an opportunity to make more on the warrants. It’s so easy a caveman could do it (WB owns Geico, love the irony).

    As much as Buffett could be construed as a villain for investing in ANYTHING BUT a “wonderful” company, the only thing I can say is that if I had the same opportunity to receive a guaranteed 6% on my money with warrants at a pretty low level I would jump at it too.

  16. MoneyCone!

    Awesome post! Love it!

  17. If I don’t like a company, I cannot invest in it. My mortgage is currently with Bank of America (after being with SunTrust, Countrywide and someone else I can’t remember) and I so wish they would sell off my loan to someone else. Once BoA got a hold of the mortgage, I started needing flood insurance, they said I didn’t have homeowners insurance and took out a policy on my behalf at an exhorbitant price,etc. Obviously I have homeowners insurance, I don’t know why I was suddenly accused of not having insurance, but I had to spend 2 hours on the phone with BoA and Nationwide to straighten it all out.

    I really don’t follow Buffett’s advice because he is in a different league than I am, and what he does doesn’t necessarily apply to what I can do.

  18. Slate.com has a great article on why Buffett’s investments are deals that no ordinary (or even extraordinary) investor can get. He is truly in his own class in terms of his access to companies and his ability to affect value perception of stocks.

  19. I guess when you’re a billionaire, you have more leverage with making deals with collapsing companies. Good for Buffett, bad for any other investor.

  20. It also depends on when you get in and out of the deals. I got into Goldman after Buffett at a lower price ($75/share), and exited Goldman at $175 per share. Its gone down since, but I locked in at near the top!

  21. By its mere nature, following ANY investor, good or bad is likely to result in lousy returns. This is because there’s always a lag between when they purchased and when this information becomes public. Furthermore, there’s an added delay between initial public disclosure and when other like-minded investors swoop in and artificially boost share prices. By the time you, as a retail investor get in, any “value” that may have been present is now overvalued.

  22. As far as I know, Buffet is an investor type so his trading range will be very large — may be yearly. So, I think the result is not tell yet so far.

  23. Buffett is a smart man, but no one should ever follow another person blindly. Like you illustrated here, Buffett is much more interested in his own bottom line than helping fellow investors increase theirs. Very good points!

  24. I admit I follow Buffet but I start following him once the stock goes below buffet’s price. I entered into GE at $17 and change and in GS at sub $110

    No one is god to make every decision correct, Buffet is bound make some mistake but that doesn’t make him any less great investor. I agree we shouldn’t blindly follow him..but do we have that insight to judge him? I doubt

  25. I am with Everyday Tips on this one. If I don’t like a company or don’t believe in what they stand for then I don’t invest in it period. I match my values with my portfolio, like you said. For me this is the only way I can be comfortable. I would rather have less money and feel good about where my money is going than to feel conflicted.

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