How to Manage Your Portfolio Like Buffett

Think of your portfolio like a diversified business, and it might just boost your returns.

Jun 14, 2014 at 10:17AM

A week ago, I wrote about a smart method of assessing portfolio performance employed by Warren Buffett. This idea -- a "Buffettism," if you will -- was first introduced in his annual letter to Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) shareholders in 1990 as the "look-through" earnings approach. Buffett described it as follows:

We also believe that investors can benefit by focusing on their own look-through earnings. To calculate these, they should determine the underlying earnings attributable to the shares they hold in their portfolio and total these. The goal of each investor should be to create a portfolio (in effect, a "company") that will deliver him or her the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than short-term stock market prospects, a perspective likely to improve results.

Buffett believes in the look-through method because it makes an investor focus on the underlying businesses, instead of using the stock price as an effective day-to-day arbiter of value. As the father of value investing, Benjamin Graham, once pointed out, the latter approach can often be misleading: "In the short run, the market is like a voting machine -- tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine -- assessing the substance of a company."

Buffetts Office

Buffett in his Omaha office. Source: YouTube, CBSNewsOnline.

Buffett apparently took this concept to heart. He developed the "look-though" method in an attempt to divert his and his investors' attention from the scoreboard (i.e., stock prices) and toward the playing field (i.e., the ebbs and flows of earnings), to employ his own baseball analogy.

In theory, Buffett's approach seems simple, but it can be a daunting task for investors to tune out the market's day-to-day noise. To determine for myself how easily this Buffettism could be applied to my stock investing strategy (or yours, for that matter), I subjected my portfolio to the look-through earnings test in a manner similar to Berkshire Hathaway.

First, I considered each of the five holdings in my concentrated portfolio as subsidiaries of a hypothetical mini-conglomerate (to act like an owner, it helps to think like one). Then, for the purposes of the following illustration, I limited my conglomerate's market capitalization to $1,000 in total, and in some cases, assumed ownership of only fractional shares to reflect allocation.

Secondly, I listed the five major holdings in my portfolio, their prices, and their market value as of May 30, 2014 in the following chart:

My Portfolio

Stock Price


Market Value

Chipotle (NYSE:CMG)




General Electric (NYSE:GE)




LinkedIn (NYSE:LNKD)




SodaStream (NASDAQ:SODA)











The calculation above provided me with the market value of my hypothetical subsidiaries, and from there I could assess the earnings stream I would derive from these operations, should they all be paid out. The portion of each company's last 12 months' earnings attributable to my portfolio is shown below:

My Portfolio



My Earnings
(EPS x # of Shares)





General Electric



















In the end, the two charts above took a mere 30 minutes to pull together, yet they produced a highly valuable x-ray of my holdings. Using this information, I was able to assess my portfolio's price-to-earnings (PE) ratio and earnings yields quite easily:

Pe And Yield

Next, I compared these metrics to stock market averages to get a sense of my risk-reward balance relative to an investment in something like the S&P 500 index. What I found is that the S&P 500's P/E ratio of 18.26 is actually significantly lower than my portfolio's, which stands at 28.91, as shown above. This is likely because of the nature of my few high-growth businesses, which are more focused on expanding the top line than current earnings today. Thus, the S&P 500's earnings yield of 5.21% also beats out the 3.46% earnings yield generated by my mini-conglomerate.

Help yourself ask the right questions
Now, what does all of this tell me? Well, for one, that I might have an appetite for risk above and beyond that of a passive index fund investor. But more importantly, it sheds light on the nature of the high-growth but cash-intensive businesses in my portfolio, which includes nearly everything outside of General Electric.

To pry deeper, I might want to consider the free cash flow (FCF) of these businesses, perhaps generating a price-to-FCF metric in the same manner. Are certain companies sacrificing earnings and reinvesting cash flow heavily? Is this a wise move, and does it bode well for the earnings stream of my conglomerate over the next 5 to 10 years? After all, given my current earnings yield of only 3.46%, the expectation is that future earnings will expand rapidly enough to compensate for the current discount relative to the S&P 500.

At the end of the day, these are the types of questions I should be asking about my portfolio, but they're the ones I often forget. Instead, I might find myself fretting over stock price swings related to Chipotle's guacamole scare or the ongoing speculation over GE's blockbuster buyout.

There are definitely better uses of my valuable research time, and I imagine a regular look-through earnings test would help to focus my investing energy. Hopefully you'll take a moment to apply it to your mini conglomerate as well, and feel free to use my web-based spreadsheet as a starting point for your analysis.

While it's impossible to replicate Buffett's every move in the market, it's perfectly practical to manage your portfolio just like the Oracle.

Here's one investment to get you started
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!

Isaac Pino, CPA owns shares of Chipotle Mexican Grill, General Electric Company, LinkedIn, SodaStream, and Yahoo. The Motley Fool recommends Berkshire Hathaway, Chipotle Mexican Grill, LinkedIn, SodaStream, and Yahoo. The Motley Fool owns shares of Berkshire Hathaway, Chipotle Mexican Grill, General Electric Company, LinkedIn, and SodaStream. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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