Over the years, much has been written about the process and criteria Berkshire Hathaway (NYSE:BRK.A) Chairman Warren Buffett uses to identify and evaluate investments. While people have paid much attention to analyzing his investments, the other half of his investment process -- buying -- is too often neglected. When it comes to making the actual transaction, he has made it clear that waiting is the name of the game.
It is no secret that Buffett is an extremely confident and patient investor. He knows opportunities will appear with time and he is content to sit on his hands indefinitely until those opportunities emerge. At Berkshire's annual general meeting in 1998, he remarked, "We're not going to buy anything just to buy it. We will only buy something if we think we're getting something attractive ... You don't get paid for activity. You get paid for being right."
Wait for the fat pitch
Buffett equates the need to be patient to baseball great Ted Williams' swinging methodology. "In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his 'best' cell, he knew, would allow him to bat .400; reaching for balls in his 'worst' spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors."
Unlike many traditional portfolio managers, judged as they are on short-term performance, individual investors can afford to wait for the fat pitch. As Buffett says, "The stock market is a no-called-strike game. You don't have to swing at everything -- you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'"
Since screaming fans don't tend to congregate around individual investors, we should have no problem waiting to buy Coca-Cola (NYSE:KO) at $40 rather than $80, Disney (NYSE:DIS) at $15 as opposed to $40, or even Microsoft (NASDAQ:MSFT) at $50 instead of $120. The goal is to buy good, understandable companies whose future prospects you feel are certain. It is not enough, however, to simply buy an "inevitable," such as Gillette (NYSE:G) and call it a day. "You can, of course, pay too much for even the best of businesses. The overpayment risk surfaces periodically ... Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid."
So, instead of "swinging indiscriminately" at every pitch, investors should reject the current returns offered by the market (if they are unsatisfactory) and be willing to go against the crowd. While it may be lonely, your patience will pay off. In May 2000, for instance, tax-preparation giant H&R Block's (NYSE:HRB) stock got pummeled after failing to meet the Street's quarterly expectations. The stock fell from $20 (post-split), down to just over $13 in a matter of weeks. Feeling the market had, as it often does, overreacted, Buffett swung mightily. In the two months that followed, he bought over eight million shares and ultimately increased Berkshire's stake to just under 16 million shares. By January 2001, the stock had crawled back up to $20 a share. H&R Block currently trades around $40 a share. Not too shabby.
The mathematics of patience
Where should you keep your cash while waiting on the sidelines? Believe it or not, the most successful investor in the world suggests parking your money in cash equivalents and short-term bonds. He'd rather have short-term returns of 1.75% than buy stocks or companies returning 8% to 9% "because I'm going to be holding on to those forever ... enough acquisitions like that and you end up with a very average business. So, in this low-interest environment, we have a lot of money in bonds right now."
The mathematics of waiting for a fat pitch is quite compelling. Were you to decide to invest money in a series of average companies, even if you were able achieve the high-end of Buffett's estimated returns for the market of 9%, it would take eight years to double your money (8.04 years to be precise).
But what if you, instead of investing your money today at 9%, wait for a fat pitch, a 13% opportunity? Once you invest at 13%, it will take only 5.67 years for that investment to double. This means you can wait for well over two years (8.04-5.67=2.37) to find that 13% opportunity, and still be in the same spot by the end of the eighth year. Few individual investors have this level of patience. Raise your standards and you can wait even longer.
But what happens after year 8 in our example? Your money invested at the original 8% would have quadrupled from its original after 16.09 years. The "fat pitch," on the other hand, would do so in little more than 11 years. This means you could wait 4.7 years before having to invest a dime and will still achieve the same goal.
Swing for the fences
Buffett explains one reason pitches move from the outside edge of the strike zone to what Ted Williams called the "happy zone": "Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community." While unsure of the timing or extent of these "outbreaks," Buffett advises investors to "simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."
In the midst of war in a down economy and at the tail end of an unprecedented cycle of corporate greed, it is fair to say investors aren't too cheery. If you are focused on high-quality, predictable companies, you need not worry. Many of Berkshire's best purchases were made when apprehensions about some macro event were reaching fever pitch. "Fear is the foe of the faddist, but the friend of the fundamentalist." All of this makes for perfect weather to play baseball.
When fear has swept the field, and that perfect pitch finally crosses home plate, swing for the fences. As Charlie Munger, Berkshire's vice chairman, once said, "The wise ones [investors] bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple." In investing, waiting for the fat pitch may just earn you a trip to the Hall of Fame.
Matt Logan is a long-time Fool Community member, posting under the name ltdintellusa. He owns shares of Berkshire Hathaway and Microsoft. He is a freshman at Babson College (www.babson.edu), where he is looking for summer employment. Matt welcomes your comments (or leads on a job!) on the Berkshire Hathaway discussion board or at [email protected].
