Warren Buffett: Trader in Disguise
Last week, I mentioned that I find Warren Buffett’s fans to be lacking in their analysis of what Buffett says. I focused on the popular quote, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” That’s not the only Buffett quote his fans take too literally… Another one is “our favorite holding period is forever.” That means investors believe they could buy a stock and never have to sell. The stock, if it’s good enough, would simply keep going up forever. This is another quote from Buffett that’s highly misunderstood. Today, I want to show you why.
To understand how misunderstood this quote is, let’s look at the full context from Buffett’s 1998 letter to shareholders. Buffett wrote, “In 1988 we made major purchases of Federal Home Loan Mortgage Pfd. (“Freddie Mac”) and Coca Cola. We expect to hold these securities for a long time. In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” A lot of people interpret this as meaning Buffett’s default holding period is forever. But looking closer, Buffett wrote that he expects to hold “for a long time.” This implies that he would react to changes in the environment. Buffett is ready to follow the wisdom of economist John Maynard Keynes who said, “when the facts change, I change my mind.” In fact, that is exactly what Buffett did with one of the two stocks he mentioned. Later in his letter, Buffett noted that Berkshire Hathaway owned 2.4 million shares of Freddie Mac. That position was valued at $121.2 million. That means Freddie Mac was trading above $50 at that time. Ten years later, the financial crisis hit Freddie Mac hard. Today, the stock trades at about $0.88 a share and the company is now effectively under government control. But you don’t need to worry about Buffett. He sold long ago.
Buffett Sells When Facts Change
While his “favorite” holding period might be forever, the truth is Buffett sells when the reason he bought the stock changes. And that’s exactly what he said in that widely abused quote.
Buffett is known as a long-term investor, but in many ways he acts like a trader.Buffett buys when he has a clearly defined reason for doing so. He defines several criteria for the investment, and when he is confident in his analysis, he acts. Maybe he bought Freddie Mac because the company had a competitive advantage and a management team better than its peers based on measures like return on equity. That obviously didn’t stay true after 2008. Facts can change. Buffett often wrote of the competitive advantages of newspapers. Local car dealers, furniture stores and grocers would always advertise in the paper since it was a cost-effective way to deliver their message to consumers. That was true in the 1950s, the 1970s, and even the early 1990s. By the late 1990s, though, newspapers were losing readers to the internet. Now, an entire generation has grown up without even knowing local merchants once filled newspapers with ads. As newspapers lost their competitive advantage, they lost money. The sector was a poor investment. Only recently have some leading companies found a way to make money in the new era that began over 20 years ago. While Buffett did own newspaper publishers — by understanding why he bought — Buffett also knew why he would sell. As business deteriorated, he sold. Traders need the same process. It’s important to know the reason for the trade and most important, the reason for the sell. Traders are not trying to hold stocks forever. They know better. They are looking for profits. And if the potential for profits disappears, the trade needs to be closed. Regards, Michael Carr, CMT, CFTe Editor, One Trade
Chart of the Day:Time to Sell Energy
If you took part in Chad’s multiple calls to buy energy over the past few months… Congratulations. You’ve probably done exceedingly well. The SPDR Energy Select Sector ETF (XLE) finally breached its pre-pandemic highs last week. The ETF is now up over 180% from the pandemic bottom. But now, the time has come to take profits. Yes, energy stocks could go higher from here. We’re smack in the middle of winter, when energy prices tend to be highest. And there’s no denying the recent momentum. But the thing is, it’s waning. The momentum indicators are diverging from the price action in a big way. And we now have multiyear highs to contend with on a continued push higher. I could be totally wrong. Maybe we’ll start to see bitcoin-like parabolic rises in XLE. But if you’ve been long energy stocks the past few months, now is a sensible time to take at least some profits off the table. And if you’re thinking of buying them now, be prepared to make a move quickly. I think energy stocks could give back a good chunk of these gains in the coming months. Regards, Mike Merson Managing Editor, True Options Masters