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Why You Shouldn't Follow Warren Buffett

Have you ever bought a stock because Warren Buffett bought a stock? You know, like Coca-Cola (NYSE: KO  ) or Wells Fargo (NYSE: WFC  ) ?

If so, you're not alone. In fact, thousands of investors follow Buffett's every move, and that's such a hassle for the Oracle of Omaha that he has actually (unsuccessfully) lobbied the SEC to give him a dispensation from disclosing his stock picks.

Heck, it got so bad that in 1999, Coca-Cola was trading for as much as 40 times earnings -- an unbelievably high number for a steady consumer staple that sells sugar water.

Yet, if you believe Alice Schroeder's account in her Buffett biography The Snowball, Buffett wouldn't sell Coca-Cola even then because "the price of Coca-Cola could plunge as a result."

After all, if folks had mindlessly followed Buffett in, thereby driving up the price, they would just as surely follow him out.

This has a name
When investors follow other investors into and out of stocks, or use another investor's decision to buy or sell to justify their own decision to buy or sell, you have a phenomenon called "herding."

While Buffett has been wary of passing along his stock ideas since the 1950s and '60s, it wasn't until 1990 or so that financial research established herding as a prevalent and powerful day-to-day force in the market's gyrations.

And recent research from professors Amil Dasgupta, Andrea Prat, and Michela Verardo of the London School of Economics allows us to quantify how herding affects stock prices over both the short and long terms.

We'll spoil the ending for you: Herding isn't much benefit to anyone.

Survey says ...
It turns out that institutional herding around a few supposedly great ideas ultimately leads to overvaluation and underperformance.

Money managers -- in trying to avoid being outdone by their colleagues -- flock to the same sets of stocks. In the words of the professors, "money managers tend to imitate past trades (i.e., herd) due to their reputational concerns, despite the fact that such herding behavior has a first-order impact on the prices of assets that they trade."

It's a broken system that punishes investors who aren't courageous enough to think on their own.

But wait!
Not everyone agrees that herding depresses the returns investors can look forward to. Just look at "Imitation Is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway."

The authors studied Berkshire Hathaway from 1976 to 2006 and found that "a hypothetical portfolio that mimics [Berkshire's] investments at the beginning of the following month after they are publicly disclosed also earns significantly positive abnormal returns of 10.75% over the S&P 500 index." Wow.

So, we should all be poring over Berkshire's 13-F filings and buying what Buffett and team did, right? Not so fast.

Those findings are eye-opening and impressive, but in our view, they don't offer much for prospective investors for two reasons:

  1. Berkshire circa 2009 is much different than the Berkshire of the 1970s, 1980s, and 1990s. For one, Berkshire is huge now and can only trade in mega-liquid, mega-cap stocks. More important, because of this herding behavior and its effect on stocks he likes, Buffett now favors private deals or full acquisitions over common stock purchases.
  2. The Internet has revolutionized stock investing, making more information more readily available -- at a faster pace. In other words, informational advantages are likely lessened in the digital era.

It's this latter point that got us to thinking about one of our favorite Web resources, GuruFocus.

What now?
GuruFocus is a website that tracks "the buys, sells, and insights" of the world's "investment gurus." This is a list that includes long-term outperformers like Warren Buffett, Wally Weitz, and Seth Klarman.

It's a neat website that sends out neat monthly emails, but we waver on this question: Is it a truly valuable service, or is it merely an interesting service?

After all, you shouldn't be buying or selling stocks because other investors are, and doing so may give you a false sense of security about your decision. As Ben Graham once said, "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." And that's true even if it's a really smart crowd.

So, what are the current "Consensus Picks of Gurus" (i.e., the stocks the most gurus are buying)? The list includes MasterCard (NYSE: MA  ) , Walgreens (NYSE: WAG  ) , Best Buy (NYSE: BBY  ) , Sun Microsystems (Nasdaq: JAVA  ) , and Canadian Natural Resources (NYSE: CNQ  ) -- a nice list of businesses, to be sure.

But are these sure winners over the next year, or five, or 10? No.

Who knows why these gurus bought them, or when or why they'll sell them? Was it macro opportunities/concerns? Bottom-up fundamental insights? Something they saw during a meeting with management? Are they selling because of investor redemptions?

Heck, it may be that Ron Muhlenkamp bought MasterCard because he saw that Steve Mandel bought it, or that John Hussman got Best Buy because he figured George Soros knew something.

Again, who knows?
The point is: Don't buy stocks because others are buying the same stocks. Don't simply follow Warren Buffett's publicly disclosed stock trades -- following the Oracle's moves, herd-like, is likely to lead you down an unprofitable road.

If you want to profit from Buffett's brain, you have two choices.

  1. Buy shares of Berkshire Hathaway.
  2. Study Buffett's shareholder letters, magazine articles, and body of work, and apply those lessons to your investing.

Both are good courses of action
While buying a share or two of Berkshire is a prudent course of action (Tim added to his position just a few months ago), it is worth noting that Berkshire today is very different from the more nimble version that bought shares in tiny companies such as Blue Chip Stamps, Associated Retail Stores, and Illinois National Bank.

Back then, Buffett was able to focus on good businesses at great prices regardless of size, industry, or geography -- and thus got some great deals on the very small-cap end of the spectrum.

That's what we do each and every day at Motley Fool Global Gains. As co-advisor of Global Gains (Tim) and a contributing author to the international investing chapter of our most recent book (Brian), we believe the good businesses at great prices are the small and foreign companies that American investors largely don't think are worth their time.

We have a scorecard full of these types of stocks that we believe will outperform over the long haul. You can see all our research and stock picks, including our top small-cap foreign stock ideas, free of charge with a 30-day free trial.

Click here to take us up on the offer.

Already subscribed to Global Gains? Log in at the top of this page.

Tim Hanson owns shares of Berkshire Hathaway. Brian Richards does not own shares of any companies mentioned. Best Buy and Berkshire are Motley Fool Stock Advisor and Motley Fool Inside Value recommendations. Coca-Cola is an Inside Value selection. The Motley Fool owns shares of Berkshire Hathaway and Best Buy and would like you to meet its disclosure policy.

Read/Post Comments (10) | Recommend This Article (51)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 30, 2009, at 6:05 PM, dugger1937 wrote:

    Another waste of time article. I'm about ready to drop out.

  • Report this Comment On April 30, 2009, at 6:32 PM, sickafus wrote:

    Martin Weiss and his Safe Money Report are saying the Dow is headed for 5000 you say buy stocks, he says sell stocks. Who does one believe?


  • Report this Comment On April 30, 2009, at 7:07 PM, jbrt wrote:

    have you peoples ever considered writing something POSITIVE for a change , the " doom and gloom " is getting to be like a " broken record " . Being you are the ones with all the " knowledge " WHAT SHOULD PEOPLES INVEST IN ? name a few for the record , lets see how you do .

  • Report this Comment On April 30, 2009, at 7:15 PM, gedeman wrote:

    so, buffet profits from herding and then complains he can't sell? haha we should all have such problems

  • Report this Comment On April 30, 2009, at 8:26 PM, scotchbarn wrote:

    Well, well! Amazing! Having noted that many of your articles are splattered with names like Ebay, Apple, Costco, Walmart, etc., etc., you've just given a good reason for not buying anything you recommend. And certainly not small caps, since when they become big caps we won't be able to sell them.

    A very odd article indeed. It is high time the art of good reporting is recognised by the MF team, i.e. having something original and interesting to say to the reader. This continual re-working of the same themes lacks inspiration. Ask oneself..."has this been said before...? If it has, better to forget it.

  • Report this Comment On April 30, 2009, at 8:52 PM, jc09058 wrote:

    Herding, I haven't heard that word used in a long time concerning stock purchases. Don't remember exactly where I heard either but it is so true. It doesn't even have to be one of the greats either to see that in action.

    The major points to this article, as I see it, don't follow the herd (tempting but never did anyway); buying Berkshire Hathaway is a great way to be on the ground floor if you want to buy when Warren Buffett does; reading and studying the shareholder newsletters does give you insight to how he looks at stocks and considers them to be a great company to buy in to.

    I consider this to be very sound advice. Even without someone pointing it out, it is what I've done and it was worth it. I've taken to time to study those newsletters and there is gold in them.

    While others have complained about losses, I've been busy looking for stocks over the last six months that given me a gain of 15% to 212% growth using a lot of what he talked about. Including BRKB, which I bought into for the first time ever on 6 Mar 2009, has shown me 34% growth. No joke and no BS.

    Yes, my portfolio got hit and was sitting with a 60% loss in PAPER value. I didn't whine about it, I started looking for more of that gold out there and I found it. Due diligence, research and Buffett's thoughts paid off.

  • Report this Comment On May 01, 2009, at 4:26 AM, zoot2 wrote:

    Scochbarn said "It is high time the art of good reporting is recognised by the MF team, i.e. having something original and interesting to say to the reader. This continual re-working of the same themes lacks inspiration. Ask oneself..."has this been said before...? If it has, better to forget it."

    I think you are mistaking this 'article' for journalism - it is nothing of the sort, it is nothing more than an advertisement for the Motley Fool Global Gains.

    There are some good articles on the MF, if you can get past their self-serving advertising.

    It isn't the site it once was - perhaps they've all gotten too rich?

  • Report this Comment On May 01, 2009, at 5:58 PM, blkbrd101 wrote:

    Yes, it's been a tough year for all of us. But the world's richest man -- who has made bundles of money through wars, oil shocks, recessions, and a number of market panics and sell-offs -- believes that now is the time to invest and make money: "If you wait for the robins, spring will be over."

    Our team at Motley Fool Hidden Gems agrees with Buffett. They're astounded by some of the small-cap bargains they're seeing today. If you're looking for some ideas, click here to read about their favorite stocks, free for the next 30 days.

    Already a Hidden Gems subscriber? Log in here.

    Ilan Moscovitz wishes he could own small, cute furry animals, but life is never that simple. He owns shares of Berkshire Hathaway and US Bancorp, a former Income Investor recommendation. Toro is a Hidden Gems selection. Berkshire Hathaway and Best Buy are both Stock Advisor and Inside Value picks, as well as Fool holdings. The Fool's disclosure

    This seems to be a contradiction of the article by Tim Hanson and Bryan Richards. But then the MF is trying to sell a different product. Where's the integrity?

  • Report this Comment On May 02, 2009, at 1:30 AM, ozzfan1317 wrote:

    Buffetts Principles are quite useful just dont buy a stock only because he did. I think that is what the author is trying to convey to us.

  • Report this Comment On May 06, 2009, at 2:25 PM, PricePro12 wrote:

    Want to see Real Market Fluct.. look to

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