Investors looking to gain an edge could do worse than follow the example of renowned investor Warren Buffett. The chairman and CEO of conglomerate Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has led the company to extraordinary returns, gaining 2,404,708% between 1964 and 2017 -- a compound annual return of 20.9%.
Hedge fund managers have long been a target of Buffett's ire, as he urged investors to put their money into low-cost index funds, saying that the massive fees levied by professional money managers would eat into returns.
In a move steeped in irony, famous former hedge manager Whitney Tilson is betting half of his children's college funds on Buffett.
A big bet on Buffet and Berkshire
Tilson revealed in an email to investors that he would be investing the money he set aside for his kids' college educations and dividing it among just five stocks, according to ValueWalk -- 50% would be invested in Berkshire Hathaway, 25% in The Howard Hughes Corporation, with the remaining 25% divided roughly evenly among Amazon.com, Google parent Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG), and Facebook (NASDAQ:FB).
On his decision to place the majority of the funds in Berkshire Hathaway, Tilson said that the company "has everything I look for in a stock: It's safe, cheap, and growing at a healthy rate."
Buffett has repeatedly said that Berkshire Hathaway would be an enthusiastic buyer of its own stock if it fell below 1.2 times book value, a strategy that Tilson believes will provide a floor against significant drops in the stock price.
Relying on hedge funds' staunchest critic?
In order to fully appreciate the irony of this move, a history lesson is in order.
The Oracle of Omaha famously challenged hedge fund managers, wagering $500,000 that no investment pro could aggregate the returns of five hedge funds and beat an S&P 500 index fund over a 10-year period. Only one stepped forward to accept the challenge. When the bet concluded last year, Buffett emerged victorious, with the index fund significantly outperforming the professionals.
For those thinking that this might be an anomaly, consider this: While the average hedge fund returned 8.5% in 2017, the S&P 500 gained 21.8%
"I was wrong about Google"
In 2004, Tilson famously wrote in a column that he was "quite certain that there is only a fairly shallow, narrow moat around [Google's search] business." He also said, "I believe that it is virtually certain that Google's stock will be highly disappointing to investors foolish enough to participate in its overhyped offering -- you can hold me to that." Tilson also questioned the logic of valuing the company at "nearly 200 times trailing earnings."
We all know how that turned out. Since then, Google's (now Alphabet's) stock has gained over 2,000%. More than a decade after his original pronouncement, Tilson stated that it was his "worst call ever." That decision was based primarily on valuation, he said, "in part because the stock has always appeared expensive to me, using the traditional valuation metrics with which I'm most comfortable."
Tilson now says that "Google has a very powerful virtuous cycle at work," citing its large user and advertiser bases, monetization, heavy research-and-development spending, superior product, and high barriers to entry. He also lays out a case that Alphabet's stock could double over the next four years.
Of both Alphabet and Facebook, Tilson wrote, "They dominate their respective industries all over the world; are growing rapidly; have enormous, sustainable competitive advantages in the form of brands, habits, and network effects; and have low-capital-intensive, high-margin business models that generate gobs of free cash flow."
He now believes that Alphabet and Facebook are the "two greatest businesses on earth."
A lesson learned
The lesson here isn't that investors should follow Tilson blindly into the stocks mentioned, rather that investors shouldn't fall in love with long-held beliefs -- particularly if there is evidence that they are wrong. It's never too late to make the right decision.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Alphabet (A shares), Amazon, and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Berkshire Hathaway (B shares), and Facebook. The Motley Fool has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool recommends The Howard Hughes Corporation. The Motley Fool has a disclosure policy.