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Berkshire Hathaway
Flat Wrong and Scared

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By thelegendoftomvu
March 20, 2009

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I temporarily went down over 400K on my most recent Wells Fargo Investment. As a value investor, I should be able to sleep well despite the fluctuations of the market price, but there is something uniquely disturbing about the Wells situation that I feel like writing about. Wells this year has been psychologically staggering for me. (It did the same thing to me last year, even though I made (what for me) was a gob of money off of it then).

First off, I was flat wrong this year. I publicly stated on the Wells board and the Macro Trends board that I think Wells will double in 3 years from my average cost basis (now 16.25, then a little higher), while yielding me 8% annually in dividends. Already, I have been proven wrong, because as you all well know, Wells slashed its dividend late last week. The double in three years from my cost basis, remains to be seen, but so far I am 0 for 1.

Even though I touted WFC idea on the Wells board and on the Macro board, this admission of mistake and loss is most relevant to the Berkshire Board because it involves two common mistakes committed by Buffett followers. I hope you all can learn from my mistakes (yes, even the Berkshire Hathaway "everything-is-related-to-the-Holocaust and Fox-News-is-the-Holy-Writ" board members, I want you guys to listen up too). The lessons can be valuable.

First off, if you just follow Buffett's moves without understanding what the reality of the business is, you will likely get a gut wrenching test at some point. I THOUGHT I was not going to make this mistake. I felt like I understood the reality of Wells' business quite well. Every recent report I read, there were write-downs, yes, but Wells was gaining market share, deposits, and geographic footprint, while growing its loan portfolio with wonderful spreads. There was enough cash (on hand and coming off of operations), as opposed to accounting earnings which get smacked down by the write-downs, to comfortably cover the dividend. The much maligned Wachovia deal was actually a pretty smart deal considering the tax advantages and the long-term growth prospects for Wells.

To me it seemed like a dream come true, the share-price was plummeting while the business was gaining in long-term intrinsic value. It paid a hefty dividend that seemed safe. But I forgot the lesson that Soros keeps bringing up in his books with respect to "reflexivity". This is the principle that in certain businesses the perception becomes the reality. Bears could raid Coke - short the common, manipulate the CDS market, and run untrue stories about it on Mad money or whatever. The raid might even work for a while, but at the end of the day, drinkers of coke and the business of coke is not effected by the public perception of the business. Little kids in Nicaragua still hit the wooden huts and get plastic baggies filled with coke after school. Cramer, Wall Street, and media be damned! That gives management at Coke the happy position of being able to continue to pay out dividends and buyback shares, regardless of what the market "thinks".

With a bank, in thousand of ways it is different. A bear raid can actually inhibit the banks business. Depositors can flee, business can evaporate based on market perception of your strength, and your ability to raise capital can become a dismal self-fulfilling downward spiral. This is Soros' observation that a great many hedge funds have figured out.

Buffett recently touted Wells as a promising investment for the same reasons I mentioned early. He went so far as to say he is comfortable with the bank investments and he feels the prospects for Wells three years out have never been better. Sweet, I was on the record saying the same thing. . . But he alluded that his only fear is the unhappy, low-probability situation where the government forced Wells to issue common while the share-price is severely depressed. Just the perception that that could happen can create the down-ward, self-fulfilling spiral that ACTUALLY affects the business. So when wall street says, cut your dividend and increase tangible equity, even though Wells apparently did not need to, management responded, "how much, sir?" And the worst case scenario can still happen. Moreover, there are some shadowy forces who are trying to profit off of making it happen. And if there is a way, they'll make it happen.

This leads me to the second common mistake in following Buffett. The first is not understanding the reality of the business and suffering a psychological loss of confidence as a result. The second common folly is to say you are a long term holder when you have a short-term attention span AND short-term demands. You must be able to stay solvent longer that your investments stay cheap, otherwise you have no business whatsoever calling yourself a value investor or being anywhere near the stock market. I think it was GDFelice who showed what would happen if Berkshire's bank investments went to zero :not much in the long-term scheme of things. When the dividend got cut: BIG DEAL. Buffett wanted it to get cut. He wants Wells to reinvest in the business right now while the system is in disarray. If part of your short-term income scheme relied on that dividend, you are mistaking your situation for Berkshire's which is the ultimate folly.

Even if you follow Buffett's lead, you must understand the business, you must be psychologically strong, and you must not mistake Berkshire's financial position for yours. I am all-in in stocks right now. I even sold my BMW and downgraded to a Prius and bought more stock with the difference. Now that Well's dividend got cut, I am cutting my own budget, because it effects my ability to stay solvent longer than the market stays depressed. It was surprise and mistake on my behalf.

Those are my lessons learned the hard way this time around. I got greedy while other were fearful, but I also got burned by own hubris. The size and scale of this market slide is not surprising to me. For many years, I have been expecting and waiting for it to happen. Those of you who have read my posts on the Fool and (before that) on yahoo message boards (johannesclimacus, greengrassgraves), know that I have been expecting this for quite some time. This is not because I had any great insight. I paid attention to the people who know what they are talking about. I had diligently read the warnings of Warren and Charlie about a coming denouement in derivatives for over 7 years. And Seth Klarman kept saying and writing that an "avalanche of opportunity" was coming and that Alan Greenspan was an "increasingly dangerous man". More tellingly, Klarman warned that there was a bubble in what he called "value pretenders." These pretenders were bound to get washed out in the coming avalanche, he warned. He did not name the "value pretenders" by name, but we can assume "value investment professionals" at the Motley Fool or even a celebrated "value investor" like the Bill Miller - whose optimism and self-promotion belied that they had not cut their teeth on a REAL financial crises - would be among those unceremoniously washed out. So too we could assume that if Klarman were right, people like you and me - people who overpopulate value investment message boards and parse the word of gurus would be washed out too. In that group, I also place the people who feed off of us, like OID and Value Investor Insight - those people make money selling subscription to people like us, rather than actually knowing what they are talking about. And lastly, I refer to all of the people who write books about Warren Buffett - how to trade like him, think like him, and dress like him - are among those due for a comeuppance (Thank god. That group contains some serious d-bags). All of these people (myself Included) - how they spend their time and try to make their money - were a sign that we were rocking ever so gently in the value investment boat next to a Niagara Falls.

When all is said and done, I bet Wells is still a great investment from here and I will be the wiser and leaner for having burned but not killed myself with my value pretending. I wish that you all can learn from my mistakes.

Best,
TOM VU