Saturday, July 14, 2007

The Fallacy of "Buffett Can't Buy More"

Since my initial post of Berkshires' (BRK.A) WEB and the replies, there has been quite a bit of discussion on the topic out there. I will not specify any bloggers because I have no desire to have a virtual battle with anyone, but, as before, I invite anyone to refute me and I will be happy to post it here. The more diverse discussion the better, right? If any blogger wants to have public discourse about this, I am happy to do so, I just am not the type to blindside someone.

Here are the initial posts, here and here, read them so at least we are on the same page.

Recently the line of thinking out there is that due to Berkshire's size and the various SEC regulations surrounding stock purchases, this prohibits large stakes in public companies at prices Buffett is willing to pay. It says that because Berkshire can only buy up to 1% of a companies daily volume without disclosing it is doing so, it cannot make purchases of a percentage to Berkshire size that it did in the past. Essentially, when you are a $100 million company investing 20% in a single stock is a whole lot easier than investing 20% of the approx. $50 billion Buffett sits on today. This is all very true, but, here is the rub: If we look at a few of the Berkshire purchases the last few years, this reasoning for Berkshire not buying more just does not hold water.

In order to continue we need to some to agreement on a few things:

1- Buffett only buys stocks he considers a value
2- He would not invest expecting only a "small return" on an equity. This is despite his public proclamations, this is called "under promising and over delivering". He has been saying essentially the same things for the past two decades. Not buying it anymore.

WalMart (WMT)

Berkshire first announced a Walmart stake in 6/2005 and added to it in 9/2005 for a total of 34 millions shares at an average price of about $48 a share. The prevailing thinking out there now is that Buffett just could not buy more once the initial stake was announced because copy-cats poured into the stock and pushed the price above a level Buffett would be willing to pay. But WalMart has essentially traded at or below Buffett's purchase prices since he bought shares! He could easily have made WalMart a substantial Berkshire holding. When you consider WalMart trades 13 million shares a day, Buffet could have bought about 760,000 shares a day.

Johnson & Johnson (JNJ)

In the spring and summer of 2006, Buffett bought 26 million shares of JNJ at $59 a share. He sat there for the next year as the stock price fluctuated around the almost $64 a share price he bought another 22 million shares at in the spring of 2007. Berkshire now owns 48 million JNJ shares that represent just under 3% of Berkshire's assets. Could Berkshire have bought much more at prices it clearly was willing to pay in the past year and a half? Yes. JNJ trades almost 9 million shares a day and even with Buffett gobbling up 22 million more shares, the price of JNJ stock fell precipitously during the spring of 2007 from $67 to $60. This means that even with him purchasing just about the maximum number of shares in order to avoid public reporting, his activity did nothing to cause a "jump" in the stock price.

These are just two quick examples. Now there may be many reasons Buffett did not take bigger stakes. Since he has never said, we will never really know. What we do know, is that the common excuse "he just can't do it because of SEC regulations and reporting requirements" just does not wash. Even Munger inexplicably jumped on this bandwagon recently when he claimed as much. Now, for some of the smaller companies Berkshire has taken stakes in this is entirely true but the above reasoning is being used to eliminate any conversation of why Berkshire stopped "swinging for the fences" almost decades ago. If you did deeper into purchases that past three years there are many examples of companies Berkshire took stakes in that the opportunity to take much larger stakes at or below the original purchase price was there (USB, for example), they just chose not to. It had nothing to do with the recently espoused reasons. Let's not forget additionally that Buffett is one of the few folks out there that the SEC actually allows to delay reporting of purchases while he finish building his positions. Even without this grace period and even after his stake has been announced, a larger position in Budweiser (BUD) was available.

Warren "can" build Berkshire portfolio changing positions, he just "chooses" not to. That is ok, but let's just admit that and let go of the excuses.

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