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The Home Run Stock Buffett Can't Buy

By Anand Chokkavelu, CFA - Updated Nov 10, 2016 at 4:42PM

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But you can.

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.

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Stocks Mentioned

Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$417,401.43 (3.75%) $15,101.43
Altria Group, Inc. Stock Quote
Altria Group, Inc.
$43.40 (2.09%) $0.89
The Coca-Cola Company Stock Quote
The Coca-Cola Company
$63.04 (1.88%) $1.16
General Electric Company Stock Quote
General Electric Company
$67.08 (4.70%) $3.01
Caterpillar Inc. Stock Quote
Caterpillar Inc.
$185.49 (3.82%) $6.82
Mastercard Incorporated Stock Quote
Mastercard Incorporated
$330.50 (4.34%) $13.74
Pfizer Inc. Stock Quote
Pfizer Inc.
$51.59 (3.00%) $1.50

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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