The Man Who's Shorting Buffett

There are certain things in life you just don't do. You don't tug on Superman's cape. You don't spit into the wind. You don't pull the mask off that ol' Lone Ranger, and you definitely don't short Warren Buffett. 

Apparently, that's a lesson Doug Kass is determined to learn the hard way.

A short introduction
Kass is the founder of Seabreeze Partners, a fund dedicated to selling stocks short. According to Seabreeze's Web page, Kass seeks "a view which differs from the market's prevailing bias." I think it's safe to say that by shorting Berkshire Hathaway, Kass has successfully found the variant view he was seeking.

In a recent article and a brief debate on CNBC (video clip, requires registration) with my Foolish friend Bill Barker, Kass presented his case against Berkshire. Although I found most of his arguments weak, I will admit that his position is not entirely without merit.

But there's one equation that Kass has overlooked -- and I think it will cost him, big time.

Buffett + cash + cheap stocks = $$$
The Oracle of Omaha is sitting on a $38 billion war chest, and he's likely licking his chops as the stocks of quality companies get punished alongside their less-polished peers. As Bill Barker astutely noted in that CNBC segment, "You have to respect ... the equation of Buffett armed with a whole lot of money and better values out in the market."

In this type of environment, Berkshire may finally have the opportunity to deploy some of the cash it has been criticized for sitting on. Should the market pick up from here, we're staring at a serious potential catalyst.

So I wouldn't be caught dead shorting the stock -- but I'm also in no hurry to buy Berkshire shares. There are better bargains out there right now.

Better bargains than Berkshire
My colleagues and I have been saying for weeks now that many good stocks were outrageously cheap. I have no doubt that Buffett has noticed this as well. But while we're free to exploit Wall Street inefficiencies and pick the cheapest stocks around, Buffett is extremely limited in what he can buy.

As I've pointed out before, it's simply not worth Buffett's time to research or buy small-cap stocks. Berkshire is so large that even owning the best-performing small-cap stocks wouldn't noticeably budge its bottom line. Buffett himself admitted as much at Berkshire's 2007 shareholder meeting:

If I were working with a very small sum ... I'd be doing almost entirely different things than I do. Your universe expands -- there are thousands of times as many options if you're investing $10,000 rather than $100 billion, other than buying entire businesses. You can earn very high returns with very small amounts of money. Not everyone can do it, but if you know what you're doing, you can.

Small wonders
Fortunately for those of us who make investments in "three-zero" denominations, there are plenty of potential bargains out there. Here are a few of Berkshire's biggest holdings, and a smaller alternative in a similar niche that I believe will provide greater stock price appreciation.

If you like:

Company

Industry

Market Cap

Expected 5-Year
Growth Rate

Moody's (NYSE: MCO  )

Financial Services

$8.7 billion

9.7%

Comcast (Nasdaq: CMCSA  )

Media

$56.4 billion

14.6%

UnitedHealth Group (NYSE: UNH  )

Health Care

$32.7 billion

13.5%

Consider investing in:

Company

Industry

Market Cap

Expected 5-Year Growth Rate

Equifax (NYSE: EFX  )

Financial Services

$4.5 billion

11.3%

NDS Group (Nasdaq: NNDS  )

Media

$3.0 billion

22.3%

WellCare Health Plans (NYSE: WCG  )

Health Care

$1.6 billion

17.0%

Data from Yahoo! Finance.

Smaller is better
Small-cap stocks may not be appropriate for Warren Buffett's portfolio, but if your net worth isn't measured in billions, it might make sense to increase your exposure to this segment. That's especially true in volatile markets like today's, where investors tend to punish small caps excessively, allowing us to buy our favorite companies on the cheap. 

At our Motley Fool Hidden Gems investing service, we've identified a number of small-cap stocks that we believe are poised to crush the returns of both the general market -- and maybe even Berkshire Hathaway. You can read detailed recommendations of all our small-cap picks and see our best bets for new money now by joining the service free for 30 days.

This article was originally published March 24, 2008. It has been updated.

Rich Greifner loves small-cap stocks and mid-major schools. He owns shares of Moody's. The Motley Fool owns shares of Berkshire Hathaway. Berkshire, Moody's, and UnitedHealth are all recommendations of both Inside Value and Stock Advisor. The Fool has a disclosure policy.


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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 June 24, 2008, at 8:36 PM, rkm238 wrote:

    Rich,

    While I certainly would never underestimate Warren Buffet (the guy is a genius), the growth cycle in the US is coming to an end. We are now bankrupt, ill prepared for the energy crisis and water shortages, our infrastructure is crumbling, we have created massive wars and as a result of our attitude are not well liked around the world.

    Take Moody's for example. In the old model of the American economy, this company worked great. Over the past 5 years though, Moody's has largely been responsible (along with S&P, Fitch) for creating this asset backed mess.

    I agree with Kass on this one - Warren's time may be coming to an end along with that of our great nation.

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