Warren Buffett’s Confession
Back in 1964, Buffett bought a struggling New England textile maker called Berkshire Hathaway.
At the time, it had an accounting net worth of $22 million.
After analyzing the financial statements, Buffett concluded the company was worth way more.
In explaining why he bought it, Buffett said at the time: “We bought Berkshire Hathaway at a good price.”
He kept pouring money into the business, telling himself the company would turn around.
Several times across various Annual Reports he talked about the importance of the textile industry. And how they had the right people in place to fix any problems.
This went on for 21 years.
It turned out that he was very wrong and eventually sold the business in 1985.
To quote Buffett from his 1985 Annual Letter, “in the end nothing worked and I should be faulted for not quitting sooner.”
He was caught in a value trap.
Despite all of the finest fundamental analysis in the world, he ended up wasting a ton of money and time.
Later he admitted it was the worst investment of his career… a “monumentally stupid decision.”
Could he be making the same mistake again?
The company IBM is currently Berkshire’s 4th largest holding. He thinks the stock is so cheap that it is a guaranteed steal.
But in the past three years the stock has dropped from over $200 to around $142 per share.
That’s a loss of 29%!
IBM trades lower today than when he first started buying the company in 2011. But he has continued to purchase shares over the years.
This could just be another example of a value trap.
If the best investor ever can fall into value traps, what makes you think that you can’t?
That’s the problem with buying stocks that are “cheap.”
Often these stocks end up being dead money and dead time. The opportunity cost of another investment is not considered.
How many times have you bought a beaten down stock you thought was cheap, only to watch it fall even more?
Buying low often means you’re buying on bad news or when something is out of favor.
Sure, you might get lucky and see a quick recovery every now and then…
But more often than not, the stock will either keep moving lower because there’s something wrong with the company…
Or you’ll have to wait for a very, very long time for things to turn around.
Buffett’s exemplary track record will lead you to believe you can wait for a turnaround.
Good luck. If you had followed his investment in IBM, for example, you would already be waiting 5 years!
Why Buffett is Wrong and the Market is Right
If you want to make money in any market you need to mirror what the market is doing now.
If the market is going down and you are buying, the market is right and you are wrong.
If the market is going up and you are selling, the market is right and you are wrong.
The market is always right. The price is always the truth.
Other things being equal, the longer you stay right with the market the more money you will make.
The longer you stay wrong with the market, the more money you will lose.
Just look at the recent drop in oil as a crystal clear example…
Oil went from $100 in the summer of 2014 to less than $30 recently.
What if you thought the low was $75 or $50? You’d still be at a loss today. Or even worse, you may have already run out of money to keep buying lower!
How do you know when the low has occurred? This is the common challenge among value investors.
Buying into a falling price is a losing strategy unless you have more money than God (a loss won’t hurt you too bad)… or you will live forever (you can wait for a turnaround.)
Trend following on the other hand does not add more money to losing positions. And it keeps you from risking more of your hard earned money on positions that might never recover.
That is no small distinction. It’s huge. It’s life changing.
What to Do with IBM?
Despite recent IBM share weakness, Warren Buffett continues to buy more.
I’m sure many investors are following his lead. Perhaps, they are blindly copying him with no real plan of their own.
They might conclude the stock is a bargain after looking at earnings reports, forward guidance, and the current P/E ratio.
But that fundamental analysis is flawed or at best incomplete.
And do you ever even know all of the fundamentals? What are all of the fundamentals?
Even if you know accurate balance sheet numbers, how does this help you determine when or how much to buy or sell? It doesn’t.
Despite the recent short-term rally in the shares of IBM, I’d stay away from the stock.
According to my proprietary trend following system, it remains in a downtrend.
Don’t get stuck in value traps. Instead, follow the trend.
Make more money in the direction of the trend and lose less money when it doesn’t go your way.
At the end of the day, that’s all we really want, isn’t it?
Please send me your comments to email@example.com. I’d love to hear your thoughts. Please tell me exactly what you think. Don’t sugar coat it!