How to tap into Warren Buffett's abilities

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Michael Fowlkes 09/01/2014

Through the years there have been plenty of highly successful investors, but few, if any, have captured the attention of so many as legendary investor Warren Buffett. His successes through the years speaks for themselves, and is the primary reason why so many investors track his holdings and do their best to "trade like Buffett".

There are a couple of different ways that you can try to emulate the "Oracle of Omaha". The first, and in my opinion the most difficult way, is to study his quarterly reports, dig through the numbers to determine which stocks he is buying or selling, and try to harvest information from his moves. This approach allows you to understand which sectors he is bullish on, and which stocks in particular he believes have a bright future ahead of them.

This is a valid strategy, and can prove very successful. By investing in the same stocks as Buffett, you are able to tap into his vast resources, and take away some of the guess work in picking strong companies. There is one main problem with this approach, and that is the time lapse between when he makes his moves, and when the information becomes readily available.

The time gap can lead to results that greatly underperform the results that Buffett is able to generate with his moves. In investing, timing is everything, and if you are working on delayed data, even if the delay is only a month or two, the impact can be severe. You will be buying after he buys, and selling after he sells. That is why relying on quarterly reports creates a major problem when trying to emulate Buffett's results.

Before we discuss a more favorable strategy, let's discuss for a minute why copying Buffett can lead to market-beating results.

One of the advantages that Buffett has, due to his reputation and vast amount of capital to invest in companies, is that he has the ear of company management. If he has questions or suggestions regarding a company's business, he can simply pick up the phone and make a call to the company's CEO. This is a resource that very people posses, and can allow him to make decisions based on credible information taken from those conversations. I am not suggesting that he is doing anything illegal, or taking advantage of any insider information, but simply that he is able to interact with the people that really know what is going on with a company'. This sort of information can help him determine the best places to invest his money.

A second advantage that Buffett has over the average investor is a team of professional at his disposal. If he wants to learn something about company XYZ, he can simply get one of his analysts to do some homework. Once again his reputation helps here since anyone representing his name will be given all the resources and information they need to build an opinion on specific companies.

What this translates to is an undeniable advantage when picking stocks. So the question is, how can we make the most of out of the information that Buffett and his team of analysts are able to assemble? We have already discussed how studying his quarterly reports can be helpful, but also may not the best route. A better approach may be to simply trade Berkshire Hathaway Inc. (BRK.B) stock. BRK.B is basically just an ETF that holds the same companies that Buffett owns, and thus is a great way to put some money to work following Buffett's ideas without having to rely on delayed press releases.

Not only does BRK.B allow you to follow Buffett on a timelier basis, but it also allows you to diversify your money over a wide range of stocks in Buffett's portfolio as opposed to simply selecting a stock or two from his list of holdings. Diversity, when combined with timeliness, makes BRK.B a much more attractive approach to "trading like Buffett".

We can take things a step further, and add another layer of protection to our investment by using options to set up a hedged trade on BRK.B. Using options to hedge a trade on the stock not only allows us to set up a trade with a high target return, but to build in some downside protection so that we can realize our target return even if BRK.B trades lower while we are holding our options.


Chart courtesy of stockcharts.com

A nice hedged trade on BRK.B would be the December 120/125 bull put credit spread. In this trade, you would sell the December 125 put while buying the same number of December 120 puts for a credit of 30 cents. This trade has a target return of 6.4%, which is 20.6% on an annualized basis. The stock is currently trading at $136.78, which gives the trade 8.4% downside protection.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Originally published on InvestorsObserver.com


This article appears in: Investing , Options

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