Buy It Like Buffett

It took him long enough.

At the end of 2004, Warren Buffett's Berkshire Hathaway had around $44 billion in cash. Ditto for 2005. And 2006. And, yes, 2007 as well.

At one point, more than 20% of Berkshire's assets were earning money market returns. While armchair investors complained that the company had amassed too much capital to continue its market-thrashing ways, Buffett simply sat on Berkshire's enormous pile of cash. And waited. And waited. And waited some more.

He refused to buy until the time was right.

The time is right
Buffett has called the current mess an "economic Pearl Harbor." He's also said, "In my adult lifetime, I don't think I've ever seen people as fearful economically as they are now."

These weren't just words. Mr. Greedy-When-Others-Are-Fearful started stuffing money where his mouth was.

That $44 billion that Berkshire had at the beginning of 2008? By the end of last June, Buffett had spent it down to $31 billion, via deals including Berkshire's purchase of Marmon Holdings, the Mars purchase of Wrigley, and the Dow Chemical takeover of Rohm and Haas. He even bought up auction-rate securities at bargain prices.

And in the second half of the year, he accelerated the buying. It's nice to have cash when the credit markets are frozen.

Last fall, Buffett committed:

• $4.7 billion to purchase Constellation Energy for $26.50 per share. (The deal later fell through, but not without Buffett pocketing a hefty breakup fee of about $1 billion.)
• $5 billion to purchase perpetual preferred stock in Goldman Sachs. He not only gets the hefty 10% dividend, but also receives warrants allowing him to buy $5 billion of common stock at $115 per share.
• $3 billion to General Electric, under terms similar to the Goldman Sachs deal -- except that the preferred stock is callable for a 10% premium after three years. The warrants allow him to buy stock at $22.25 per share.

Buffett was willing to put more than $20 billion to work over that one-month period (although, again, the Constellation deal ultimately fell through). On top of that, he penned a "Buy American" op/ed piece in The New York Times, saying he was putting personal money to work in U.S. equities. Buffett's back, baby!

Buffett's buying. Should you?
Historically, average investors could simply ride Buffett's coattails to returns that easily doubled the market's. But this time is different.

Buffett got sweetheart deals on both Goldman and GE. In the case of GE, he's earning 10% dividends on a company that was AAA-rated at the time. If he buys the warrants and they pan out, he'll earn even more.

When Buffett made those deals, he was providing much more than just capital. He was lending his credibility. That meant Goldman and GE were willing to give him great deals in hopes that his name alone would stabilize their stock prices for follow-on offerings.

In other words, don't buy into Goldman or General Electric just because Buffett has.

Learning from Buffett
Instead of buying what Buffett is buying, we should look to what his strategy has to teach us. So what can we learn from his shopping spree? Two things:

• Invest for a lifetime.
• Compile a watch list of attractive companies.

Buffett's pushing 80, but he hasn't been panicking and trying to make a quick buck, no matter what the market has done. Instead, he's been investing for the long term. In the past few years, that's meant waiting for opportunities to present themselves. Now that they are, he's been striking with a vengeance.

Because of his patience, he hasn't had to compromise -- and he's getting great companies at great prices. When Constellation Energy's price dropped so precipitously a year ago (from above $60 to the $20s), he was ready to pounce. Goldman and GE may have approached him, but you can be darn sure that he'd already done the bulk of his research beforehand.

Follow Buffett's lead
To be great investors, we need to be similarly prepared. In volatile times like these, Mr. Market presents us with loads of great values -- but just because a stock price has fallen, that doesn't mean a given company is a good value.

To wit: Here's a screen of companies with market capitalizations above $5 billion that are trading substantially off their 52-week highs:

Data from Capital IQ, a division of Standard & Poor's.

You've probably heard of most of these companies, and perhaps you find their discounts tantalizing. But some of their current valuations are still not that cheap, and some of their business models may be outside your circle of competence. There are a lot of other great companies in the market, too. Plus, they all may be discounted further. How should you proceed?

One prudent way is to take emotion out of the equation: Compile a list of companies you'd love to own for the long term and the prices you'd love to pay for them. When one of your favorite companies goes on sale, you can revisit your list, ensure your investing thesis is still intact, and bend it like Buffett.

If you're looking for some more help compiling your list, you can see what Fool co-founders David and Tom Gardner are recommending to subscribers at Motley Fool Stock Advisor. Like Buffett, they look for premier companies that they can hold for the long term -- and you can view their recommendations free for 30 days by clicking here. There's no obligation to subscribe.

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This article was originally published Oct. 13, 2008. It has been updated.

Anand Chokkavelu owns shares of Berkshire Hathaway. First Solar is a Motley Fool Rule Breakers selection. Berkshire Hathaway is a Stock Advisor pick. Berkshire Hathaway and Nokia are Inside Value picks. The Fool owns shares of Medtronic and Berkshire Hathaway and has written puts on Medtronic. The Fool has a disclosure policy.