The Home Run Stock Buffett Can't Buy

Warren Buffett gets opportunities the rest of us don't. He's the name-brand investor companies go to when they need cash or a smidge of reputation in a hurry.

I have previously chronicled the crazy-sweet terms Goldman Sachs and General Electric (NYSE: GE  ) gave Buffett . How crazy-sweet? They begged Buffett -- technically his company, Berkshire Hathaway (NYSE: BRK-A  ) -- to lend them money at a guaranteed 10% plus equity upside.

But before you get too jealous, know that this wasn't always the case.

How Buffett made his opportunities
Let me take you back to a time when Buffett wasn't worth 11 figures. Back to a time when he had only five figures to work with.

In his 20s, Buffett's eventual avalanche was just a snowball. All his name could get him was a dinner reservation ... if he called ahead.

So he had to work to find deals to invest in -- deals that would form the basis of his fortune. He sought out the master investors of his time, including his hero Benjamin Graham, and learned everything they would teach him.

But more than anything, he did the legwork that others weren't willing to do. In this time before the Internet, he'd physically go to Moody's and Standard & Poor's to read old reports, to the SEC to read filings, and to company headquarters to talk with management.

His persistence was rewarded handsomely, particularly in tiny, underfollowed companies. In Buffett's own words: "I would pore through volumes of businesses and I'd find one or two ... that were just ridiculously cheap."

How cheap? In one six-year period, he grew his wealth by more than 60% a year. By age 26 he had amassed so much wealth that he considered retirement.

How Buffett lost his opportunities
Of course, he didn't retire. In the decades since, he's continued putting up incredible returns, and he's laid claim to the unofficial title of greatest investor ever.

But with all this wealth comes a problem.

That problem is exemplified by Buffett's recent purchase of the Burlington Northern Santa Fe railroad -- which he admits wasn't a particular bargain.

The man who has absolutely throttled the market for more than five decades now says, "Reasonable return is good enough. ... I mean, 50 years ago, I was looking for spectacular returns, but I can't -- I can't get them."

Why the surrender? One word: size.

Berkshire Hathaway is roughly the size of a General Electric, a Pfizer (NYSE: PFE  ) , or a Coca-Cola (NYSE: KO  ) . Buffett's empire has grown so large that the small multibaggers he used to stalk no longer make a dent in his portfolio's returns.

For Buffett, analyzing and buying a small-cap stock has roughly the same cost-benefit as us walking a mile to pick up a quarter. Instead, he's stuck stalking elephants like Burlington Northern, which is roughly the size of a Caterpillar (NYSE: CAT  ) , an Altria (NYSE: MO  ) , or a MasterCard (NYSE: MA  ) .

Could he still do it today?
When Buffett could stalk mosquitoes instead of elephants, his returns were consistently monstrous. That was a long, long time ago, though. Could he still do it today?

He thinks so. He says, "It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."

Wow. Now, before we get carried away, that's the greatest investor in the world taking on the market with no restrictions.

The takeaway for us mere mortals is that there's more opportunity for outsized returns in small-cap stocks than there is in larger-cap stocks.

The home run stock Buffett can't buy
It's nice to know we have one advantage over Warren Buffett. For an idea of how to take advantage of said advantage, I turned to our small-cap experts at Motley Fool Hidden Gems.

They recommended doing the same type of work Buffett did back in his heyday -- studying the master investors, vetting company management, and digging into financial statements to find strong balance sheets and large margins of safety.

Using this process, they've unearthed Neutral Tandem, a fledgling telecommunications network play that is disrupting the switching services provided by the Baby Bells. Backed by a cash-rich balance sheet, its growth opportunities lie in the increase of voice and data needs as well as its own geographic expansion.

The Hidden Gems team has put their money where their mouth is on Neutral Tandem, buying shares of it in the real-money portfolio they manage for the world to see. If you'd like to see what else they're buying now, you can take a 30-day trial absolutely free. Just click here to get started.

Anand Chokkavelu owns shares of Berkshire Hathaway, Burlington Northern, Altria, and Pfizer. You can follow him on Twitter. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Berkshire Hathaway, Coca-Cola, and Pfizer are Inside Value choices. Coca-Cola is an Income Investor pick. The Fool owns shares of Neutral Tandem and Berkshire Hathaway. The Fool has a disclosure policy.


Read/Post Comments (25) | Recommend This Article (208)

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 December 24, 2009, at 1:02 PM, sept2749 wrote:

    I read somewhere that TNDM is increasing their business but lowering their prices as they increase business. This could eventually lead to loss of net income when the lowered prices become very wide spread. Anyone else hear about this?

  • Report this Comment On December 24, 2009, at 1:52 PM, TMFEditorsDesk wrote:

    @sept2749,

    Price competition and/or obsolescence are certainly concerns.

    As a data point for where margins are currently trending, Neutral Tandem's Q3 earnings release shows that net margins increased from 18.4% to 24.8% for the first 9 months of 2009 (vs. 2008).

    http://ir.neutraltandem.com/releasedetail.cfm?ReleaseID=4216...

    -A

  • Report this Comment On December 24, 2009, at 2:26 PM, Fool wrote:

    This stock was on the IBD Top 100 stocks not too long ago. I did some research on it and thought it looked good, but after I bought it, it cratered, and I eventually dumped it at a loss. Bummer!

  • Report this Comment On December 25, 2009, at 1:15 AM, Riot5000 wrote:

    RUN AWAY

    MF is not your best guide to buy anything.

    By the way, CROX is at $6 AGAIN,

  • Report this Comment On December 26, 2009, at 7:46 AM, Usnzth wrote:

    If you are looking for a small cap that is pretty close to a given, may I respectully offer NEP for your consideration?

  • Report this Comment On December 28, 2009, at 7:48 AM, MrsCathyGF wrote:

    As the NF says, do your own due diligence. Period.

    But the point is taken. Nimble is as nimble does. No party lasts forever.

  • Report this Comment On December 31, 2009, at 2:13 PM, animekenji wrote:

    There are too many pump and dump scams going on in the small cap world. You have to be ready to take your profits and run quickly. A small cap being pumped can increase greatly in value and then be wiped out a few minutes later when the dump part of the scam executes. Buying and holding for long term gains or dividend payments is simply too risky in small caps even if the underlying company is sound.

  • Report this Comment On December 31, 2009, at 3:49 PM, ecoloney wrote:

    BRK.B up only about 2% per year in the last 5 years. It's been a TERRIBLE stock. I own it! I would've done better in a money market fund and not had the volatility. Personally, I think old Warren has lost his edge: US Airways (went bankrupt), Occidental Petroleum (top-ticked it), now Burlington Northern Sante Fe...

  • Report this Comment On December 31, 2009, at 6:07 PM, TMFEditorsDesk wrote:

    @animekenji,

    One way to limit exposure to the pump and dump stocks is to make sure the small caps in question fit these three criteria:

    Market caps in the $200 million-to-$2 billion range.

    Listings on major stock exchanges.

    Positive cash flows and reasonable debt positions.

    I wrote about the criteria in this article:

    http://www.fool.com/investing/small-cap/2009/06/04/do-blue-c...

    -Anand (TMFBomb)

  • Report this Comment On December 31, 2009, at 8:38 PM, thisislabor wrote:

    And that comment above is seriously why I love the motley fool.

  • Report this Comment On January 01, 2010, at 1:07 AM, TheCatsMeeow wrote:

    While BRK.A is certainly not a Small Cap, I have to somewhat disagree with "ecoloney" comment.

    Back in November, I heard a similar argument about Berkshire/Buffet not being a very good investment. Realizing that the bulk of the losses were due to the last 18 months I queried 5 years prior to 6/2008. If you had purchased 1 share and practiced a "buy-n-hold" strategy you would have gained 62% (about 12%/year average). Going forward to present you gains drop to 20% (or about 3.33%/year).

    Just another case that "Buy-N-Hold" is dead!

  • Report this Comment On January 01, 2010, at 3:19 AM, automaticaev wrote:

    Buy and hold sucks

    They have a whole websight about stocks.

    Should be able to find the ones that will go up 100% + in less then a week. I am 100% serious.

  • Report this Comment On January 01, 2010, at 3:25 AM, automaticaev wrote:

    if they cant tell you what will go up 100% in a few days then motley fool are worthless and they suck at picking stocks. One of their articles i read said dosnt matter how much you buy it for all that matters is holding it forever while it goes down and eventually over the extreme long term (45 years) it will go up 12%.

  • Report this Comment On January 01, 2010, at 11:06 AM, grantrobertb wrote:

    Food for thought: Has anyone thought about the idea that Warren Buffett's interest in Burlington Northern might have more to do with Natural Gas than the Railroad itself?

    http://www.answers.com/topic/burlington-resources-inc

  • Report this Comment On January 01, 2010, at 12:30 PM, daustin97222 wrote:

    "Buy and Hold" does work. Just make sure that you buy and hold Rental Real Estate and not stocks!

    Buy where jobs are stable and pay well. Buy in college towns. Buy in magnet cities. Buy plexes when you can get them cheap.

    It worked for me. Stocks go up and down, and Out of Business. Meanwhile, people need a place to live.

    Look for all-cash deals (I did) where the rents are 7%-9% of the purchase price. Buy in the inner circle, as close as you can get to the job center. Buy in the path of Federal transportation dollars, because the infrastructure upgrade can push demand for housing. Buy when NOBODY wants them (like: right now!). Buy where rents can be increased with a facelift or a different marketing strategy.

    How well have you done in stocks over the past decade? Two decades? Why don't you consider a different approach to investing? Here's something else that I want you to think about: once you have found your little WonderStock and it has quadrupled in value and you decide to retire: when you sell it you will give a third of it to the Feds and the State (at least in my state), and THEN you will take the remaining two-thirds and look around for something safe that pays a big dividend. Or, you will put it into a CD paying 3.6215% for five years. Meanwhile, the landlords keep on cashing the rent checks paid on the units. The landlords have no conversion cost to get that high-dividend investment because they already OWN it.

    I've held stocks since the seventies (growth funds and index funds in IRAs and 401ks), and the steady-Eddie nature of my rental portfolio has completely trashed everything else by a MILE. My annual rent receipts are over ten times what my salary was back then.

    Think differently. Quit trying to look for a fast buck, because it is an illusion. Use your keyboard to look up plexes for sale in a small college town near you. Spend fifty bucks on a foreclosure site membership (no names mentioned). Today, in my town, there are plexes available everywhere for $70k/unit where the rents are $595-$725 per month. YOU do the math. Where will you be in ten years? Still looking for a WonderStock?

  • Report this Comment On January 01, 2010, at 8:22 PM, TMFEditorsDesk wrote:

    @ecoloney,

    I disagree on Buffett losing his edge. As I was alluding to in the article, Buffett is handicapped by the size of his investment portfolio.

    To use an analogy, Usain Bolt is the fastest man on the planet. However, I could beat him in a race if he had to compete while carrying 200 pounds.

    That said, I still like Buffett's odds against the market. Especially since he loaded up on advantageous investments last year.

    My colleague Morgan Housel makes a good argument for Berkshire Hathaway at today's prices here:

    http://www.fool.com/investing/general/2009/12/30/the-best-st...

    - Anand (TMFBomb), a happy Berkshire shareholder.

  • Report this Comment On January 02, 2010, at 12:27 PM, TMFEditorsDesk wrote:

    @automaticaev,

    I haven't heard of anyone who can consistently buy stocks for 100% gains in a few days.

    To put some numbers behind how amazing that would be, if you started with $10,000 and made 100% gains every month, you'd be the richest person in the world in about 2 years (sans transaction and tax costs).

    -Anand (TMFBomb)

  • Report this Comment On January 06, 2010, at 10:46 AM, sm2509 wrote:

    I am new to the world of buying stock.What would some of you vet's suggest for me?

  • Report this Comment On February 28, 2010, at 1:05 PM, marc5477 wrote:

    @ daustin97222

    The problem with real estate is two fold.

    1 - If you dont have tons of cash, then you will probably need to manage the properties yourself because hiring a manager would negate your immediate 5%-15% profit. Most management companies ask for between 10%-20% of receipts. If you have a mortgage after putting down 20%-30% chances are you will make very little from this investment for the 1st 20 years.

    This brings us to 1b

    1b - Managing property is a job not a hobby. Tenants, especially in residential property, range from dumb to plain out right careless. You will need to answer phone calls, and deal with problems often. I am not saying its a bad job to have, but if you already have a job that pays well, this might be a waste of your time.

    2 - Property, like stocks, can lose value. These past few years proved that to many people. As prices declined, so have rent rates. In pre-2009 San Diego, you would have been hard pressed to find a 2 br, 1.5 bath, 800 sqft apartment for under $1200. Now you can easily rent a newly converted 2br 2bath 900 sqft condo/townhouse (not a regular cheesy apartment) for $950. Rent has deteriorated 20% and property value has lost about 50% since 2006.

    All that being said, property is great if you can do your own management and if you can hold it for 20+ years. Its also not too bad if you can buy it outright in cash since you will be able to hire property management and still make money. Otherwise, my low risk fixed income portfolio has eclipsed both my normal securities and real estate investments handily and I had to do no work whatsoever to manage those investment. I still like real estate nonetheless.

  • Report this Comment On February 28, 2010, at 1:06 PM, marc5477 wrote:

    @ daustin97222

    The problem with real estate is two fold.

    1 - If you dont have tons of cash, then you will probably need to manage the properties yourself because hiring a manager would negate your immediate 5%-15% profit. Most management companies ask for between 10%-20% of receipts. If you have a mortgage after putting down 20%-30% chances are you will make very little from this investment for the 1st 20 years.

    This brings us to 1b

    1b - Managing property is a job not a hobby. Tenants, especially in residential property, range from dumb to plain out right careless. You will need to answer phone calls, and deal with problems often. I am not saying its a bad job to have, but if you already have a job that pays well, this might be a waste of your time.

    2 - Property, like stocks, can lose value. These past few years proved that to many people. As prices declined, so have rent rates. In pre-2009 San Diego, you would have been hard pressed to find a 2 br, 1.5 bath, 800 sqft apartment for under $1200. Now you can easily rent a newly converted 2br 2bath 900 sqft condo/townhouse (not a regular cheesy apartment) for $950. Rent has deteriorated 20% and property value has lost about 50% since 2006.

    All that being said, property is great if you can do your own management and if you can hold it for 20+ years. Its also not too bad if you can buy it outright in cash since you will be able to hire property management and still make money. Otherwise, my low risk fixed income portfolio has eclipsed both my normal securities and real estate investments handily and I had to do no work whatsoever to manage those investment. I still like real estate nonetheless.

  • Report this Comment On March 12, 2010, at 8:06 PM, realblue33 wrote:

    I find it interesting that there are several on here making negative comments about "The Motley Fool".

    One must be a paid member to get on here. So it makes me wonder if the ones making the negative comments might be brokers or advisors that have lost clients to "The Motley Fool" after clients found out just how knowledgeable and successful the site is, and the clients can do a little of their own homework and get valid, top-notch advise from proven experts at a huge savings as opposed to using traditional, high priced, so-called experts that are at best, no better.

    I joined the "Fool" to have more of my past fees to invest for myself.

    The "Fools" are proven Winners!

  • Report this Comment On March 12, 2011, at 1:08 PM, barbil wrote:

    uhhh... I didn't have to pay anything to be here. And I've been a member a pretty long time.

    Just sayin'...

  • Report this Comment On March 12, 2011, at 1:53 PM, ozzfan1317 wrote:

    I personally am shooting for 15 to 20% annually and that is primarily small and micro caps. If you are trying to make a 100% a day then you are likely gambling instead of investing but someone has to underperform so your decision is greatly appreciated.

  • Report this Comment On June 04, 2011, at 9:44 AM, sept2749 wrote:

    Buffet may be the best at what he does but I have owned Berk-b for several years and it's going nowhere. What bugs me is the shareholder's are losing but Buffet is gaining. However, I do believe it will come back a bit but unless I start seeing some money coming my way why the hech should I even be invested there? No dividends and presently no appreciation - in fact it's going down. I own many of Berk.-b holdings and am doing fine as I bought them in 2009 CHEAP. I will sell berk.-b given another year of this nonsense. They certainly have enough money (God only knows) to give us a 4% dividend. All the crap about needing money to invest is GREED. The only reason anyone buys Berk.-B is for capital appreciation which we are not getting. Come on Warren share and share alike! We've been loyal and patient and you've been cheap and unappreciative. Your words are not important - give us a solid dividend.

  • Report this Comment On November 03, 2011, at 6:58 PM, ASeaDragon wrote:

    @sept2749:

    If Berkshire were to pay a dividend, (a) Berkshire would be unable to use the money (being a sea of cash enables it to get insurance business weaker balance sheets would drive away), (b) you would pay tax on the dividend after Berkshire paid the tax to make and keep the profit, resulting in an inefficient double-taxation, and (c) if you want money out, you can sell a few shares, so you lose nothing as a consequence of Berkshire's practice.

    If you can do better than Berkshire with the money you think it should pay as a dividend, don't invest. I bought B shares at $3000/sh and $2750/sh after the panic but before the split, when BRK.B's good insurance quarters were masked by FAS 157's requirement that BRK.B report unrealized "losses" in modeled valuation of an illiquid long-term option – BRK.B was required to report "losses" due to "derivatives" when there was in fact no loss, and never would be. People sold, confused by the SEC-required income reporting, and the company continues to rake in cash.

    As Buffett himself said, markets may in the short run be a popularity contest but in the long run they are a weighing machine. All that cash Geico and the reinsurance business reel in, plus the payoffs from Goldman, GE, BoA, and everyone else with a need to tap that money BRK.B doesn't pay as a dividend, will eventually move the shares closer in-line with the company's intrinsic value. Yes, it'd be nice if everyone saw the value now – but then, where would the opportunity to buy below value be?

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