Article - How to trade like Buffett

The Complete User's Guide to Warren Buffett's Portfolio

By James Altucher
Stockpickr.com

Let’s face it. If you're going to blindly piggyback Warren Buffett's portfolio, you're going to probably lose money. By "piggyback" I mean, simply buying all his positions, closing your eyes, and hoping for the best.

That said, Buffett has been, and will continue to be, the most successful investor ever as long as he is at the helm of Berkshire Hathaway (BRK-B). Taking a disciplined approach to studying Buffett's portfolio as well as the portfolios of his close associates, can be very lucrative.

There are several keys:

Understand which positions are Buffett's old "generals" that he won't sell but nevertheless he is not excited about. Look at the prices which Buffett has purchased his most recent stocks. Understand the long-term demographic reasons for Buffett's more recent purchases. Look at the portfolios of other Buffett-like investors and funds or investors that Buffett is affiliated with. Buy the New Positions Don’t buy the old positions, the ones Buffett bought 10, 20, even 30 years ago. For instance, Buffett owns the Washington Post (WPO), which he bought in the early 70s when it was trading below its liquidation value. Don’t do it. Let’s follow Buffett’s current advice on this one. From his latest letter to shareholders: "Eventually [..] eroding fundamentals will overwhelm managerial brilliance. […] And fundamentals are definitely eroding in the newspaper industry." And even stalwart position, Coca-Cola (KO), which Buffett bought in the 80s and has had a significant gain on, I would avoid. Buffett recently left the board of directors and I would take his cue on that one. However, let’s take a close look at the new positions. USG Corp. (USG), for instance, makes building materials such as gypsum wallboards, sheetrock, ceiling materials, etc. Look at your walls and ceilings right now. Chances are USG made some of the materials in those walls. The company has been around since 1901. Buffett likes long-term players. Although Buffett purchased the bulk of his shares at prices much lower than the current price of $48, his most recent purchases occurred over the past year whenever the stock dipped below $46. Although there are no guarantees, clearly Buffett thinks USG is a strong buy at $46. USG trades at a forward P/E of 15 with revenues expected to grow double digits over the next year. The stock has suffered because of concerns about housing but over half of USG's revenues are non-residential and Buffett, a master at demographic-based investing, clearly sees that any housing slowdown won’t last forever. Next in line is Buffett's greatly increased position in US Bancorp (USB). His stake went from 6.11 million shares in March, 2006 to 23.31 million shares by December 31. US Bancorp is a perfect example of Wall Street throwing out the baby with the bath water. Because of the subprime mortgage lending disaster, people have been flushing the regional banks out of their portfolios in order to avoid any future potential explosions like New Century or Accredited Homelenders. The problem these companies have is that they lent out money to people who never borrowed money before. They did not reserve enough in anticipation of delinquencies and now the delinquencies are coming in much higher than expected. Additionally, all banks have suffered from the inverted yield curve which affects the spread they make between the money they lend out, and the money they pay depositors. However, Buffett has been buying regional banks since he first started his initial investment partnership in the 50s. There's probably no greater expert in the world on regional banks. So when we look deeper we see what Buffett likes and what Wall Street is missing as they sell off the stock: credit quality of USB's loans has actually gone up over the past quarter and management has stated that it expects credit quality will continue to rise. It turns out that they never got into the subprime lending game. Additionally, although the inverted yield curve has affected their margins, their return on equity is 23% versus an average of 10% for the banking industry as a whole. USB, which is almost 5% off of its recent lows, and is flat with Buffett's recent purchases, is probably a strong buy here. Demographics and the Retiring Baby Boomers Buffett shines when it comes to making long-term macro predictions. When energy was at a low he started buying pipeline companies and energy companies right around the fallout of the Enron mess. Before housing made its big move he started buying carpet companies and furniture companies. Now Buffett is making perhaps his biggest demographic bet ever. Retiring baby boomers are going to need healthcare. Buffett doesn't bet on the speculative biotechs though but the consistent earners that are relatively cheap, exhibiting growing earnings, and are well-positioned to take advantage of the explosion in demand that’s going to occur over the next 30 years. Johnson & Johnson (JNJ) is our first pick here. Buffett recently disclosed he owns 21.6 million shares of the company. Again, JNJ is a perfect example of Wall Street overreacting to what is otherwise small news. The stock began faltering after JNJ disclosed that there were improper sales practices in two "small market" countries. Payments were made. Cash was exchanged. Who knows? It’s being investigated. The company has stated that it won't affect earnings at all. Executives have been fired and it’s all business as usual. But now we have the pleasant circumstance of being able to buy the company at 14 times earnings, the cheapest level it’s been at in over ten years. And we get this bargain price right at the beginning of a boom in health care that will probably rival the dot-com boom in terms of the explosion in prices once people realize the extent to which the boomers are going to require the products of health care companies. Buffett bought 21 million shares of JNJ in 2006 to make it a brand new core holding for Berkshire. Also in the healthcare category is Buffett's new purchase of UnitedHealthcare (UNH). UNH stock has been floundering because of a backdating options scandal. But the company has $2.3 billion in cash to deal with any fines related to the scandal and with $6 billion in cash flows is ready and able to start buying back its own shares. Which they announced they would start doing 2 weeks ago, to the tune of a $6 billion share buyback program. The company trades at a forward P/E of 13 and is expected to grow revenues and earnings by double digits. One More Trend: China (But Through the Back Door) Buffett has often stated that he doesn't have expertise in foreign companies and that there are plenty of good investments among the 8000 public companies in the US. Well, perhaps he's taking that statement back as he starts looking abroad. In his most recent filing he revealed a position in Korean steel company Posco (PKX). It’s unlikely we can get Posco at Buffett's prices as the stock has been steadily gaining: But profits have been gaining as well. The company has a monopoly on steel in Korea, with 75% of the country's production coming from Posco. Which also means that it dominates the sale of steel to China. Although the company trades at just 10x cash flows this is a case where I would just wait for a pullback. Buffett's gotten in at good prices and with the uncertainty currently hanging over the Asian markets and, in particular, China, there might be future opportunity to get in at lower prices. That said, this is a demographic trend that Buffett is clearly moving in on. Get by With a Little Help From Buffett's Friends Another problem with piggybacking Buffett's portfolio is that he has too much money to put to work. He can't make smaller investments or buy into smallcaps and midcaps the way we can. So sometimes it’s worth it to not only follow Buffett's portfolio but also the portfolios of various FoBs, Friends of Buffett, who follow very similar investing principles to Buffett. Tweedy, Browne: once Buffett's stockbroker in the 60s, and also the managers of the eponymous enormously successful Tweedy, Browne Global Value (TBGVX) fund, they greatly increased their positions in their latest filing in Lloyd's TSB Group (LYG) and SK Telecom (SKM) and took a new position in Con-Way Inc. (CNW). Ruane Cuniff a.k.a. The Sequoia Fund (SEQUX): The fund Buffett directed investors to when he shut down his own fund in 1969 in order to become an operator at little-known Berkshire Hathaway. Since its inception the Sequoia Fund has returned an average of 15.68% per year. An interesting new position for Sequoia is eBay (EBAY) as the online auctioneer has fallen into value territory when investors lost their faith in the company after the Skype acquisition. Also worth noting, Sequoia reduced its position in Berkshire Hathaway by 10% in its most recent filing. Bill Gates: Bill Gates' personal money is invested through Cascade Investments. Gates sits on the board of Berkshire, plays bridge on a regular basis with Buffett and in recent years has become one of Buffett's best friends. So it’s natural that his stock holdings show a distinctly value bent despite his success as a tech entrepreneur. There's no need to reinvent the wheel. Buffett, the smartest investor ever, has done a lot of work for us when he buys a position and then discloses his holdings. Studying in the footsteps of the master and his disciples, but using that as a starting point for your own research, will end up being a very lucrative practice. James Altucher is founder and CEO of Stockpickr.com, author of the book, "Trade Like Warren Buffett", and partner at Formula Capital