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Commentary

Buffet Exits Bank Of America

You might think that when Warrent Buffet says "Rule One: Never Lose Money. Rule Two: Never Forget Rule One." it means that he makes money on every trade. He doesn’t. At least, not when it came to BoA:

Warren Buffett’s Berkshire Hathaway Inc. sold its stake in Bank of America Corp., ending an investment that spanned three and a half years in which the lender’s stock lost more than two-thirds of its value.

Buffett’s firm had no shares in the Charlotte, North Carolina-based bank at the end of 2010, compared with 5 million shares three months earlier, Berkshire said late yesterday in a regulatory filing that lists the company’s U.S. stockholdings.

Berkshire, where Buffett serves as chief executive officer and head of investments, entered the Bank of America stake with the purchase of 8.7 million shares in the second quarter of 2007.

This is why you shouldn’t follow what people say, follow what they do. Buffett probably never meant hold on till you make money on everything – he’s lost money in US Airways and a number of other purchases earlier. I’m sure he didn’t intend to lose money (who does?) but it doesn’t mean he’ll follow this rule forever. I wrote about this in Losses and Endowments:

Warren Buffet has two rules: 1) Do not lose money and 2) Don’t forget rule #1. It would be entirely stupid to believe he doesn’t lose money. Rules, after all, are meant to be broken, especially when your choice is to break it and lose money, or to stand by it and lose even more money.

Some might think I’m just taking Buffett’s trip – but I’m not. He’s done exactly like he should have – cut his losses and walked when it seemed it would just get worse.

There are people who mail in Buffett-isms as if they were written in stone. I’m just saying that it’s perfectly okay to violate those rules; the thinking behind investments has to be to avoid losses on average. That is, you come out winning if you make more on your winners and lose less on your losers.

A better meta rule, perhaps, and I’m not the first one to say this – is 1) Have great sounding rules and 2) know when to break them.

  • Mark says:

    >Hi Deepak,

    Perhaps this might seem like a rant, but the truth is there are too many of these “Buffet quotes” that are bandied about by people who have barely a clue what value investing is or in what context buffet made the quote. The result is I often get to see and hear people take one of his quotes, take one of his investments, or disinvestments, and glibly say, oh see he doesn’t follow what he says. Buffet’s fault, if can be called that, is that he’s manages to distill his knowledge down to very quotable quotes, and then everyone jumps in with an opinion.
    Ex: Value Investing = Buy and Hold.
    No it doesn’t. And if you think it does then I’m sorry your (not you, but everyone who believes that) knowledge of value investing is superficial at best. Value Investing simply states that you buy something worth a dollar for 50 cents. Of course, first you need to learn how to value what you’re buying – in the case of the stock market, it’s a business. If you’ve ever tried doing this you’ll realize how complicated it can be – and there are a million ways to arrive at a value range. Yes that’s right, a range. Not a single figure. If you’ve come up with a single figure, I’m willing to bet it’s wrong.
    If you’re lucky enough to cross this big test, then you pick it up for 50% off – again if the market is kind enough to offer it you at that. Now repeat.
    So what happens when the market gets generous and your business is now trading at the intrinsic value you’ve put on it? Guess what, you SELL. Yes SELL. In fact the best value investors sell when the business reaches about 90% of intrinsic value. This is value investing.
    Buying a stock you fancy, or because some taking head on CNBC says it has great “upside potential” and then holding on for your dear life in the hope it will double or whatever is not value investing. It’s just plain stupid!
    Value investing involves selling. Graham did it. And the best value investors of today do it. It’s as fundamental a part of value investing as picking up a good business at a 50% discount.
    So what of that other great buffet quote : “My ideal holding period is forever”. Well to start with there are six words in that quote, and the most important one ISN’T FOREVER. (As every trader and his uncle will often throw at you when you mention VI). IT’S IDEAL. Yes Buffet is talking about an ideal situation and to make sense of this quote you need to know what an ideal situation is according to buffet. 99% of the people who use the quote haven’t a clue.
    If you’re lucky enough (and you need to be lucky, as well as diligent, and a lot of other things that involve hard work) to get yourself a great business at a 50% discount and the business is the kind that can deploy capital and earn a return significantly greater than its cost of capital consistently, that is it can keep growing it’s intrinsic value year after year, then why the hell would you sell?
    You’d be mad too – especially if you’ve done all the hard work and patience you need to.
    So what would you do? You’d hold on, if you could, yes here it comes, forever!

    It’s basic common sense. And it’s simple.
    Which is exactly why buffet said, “It’s simple, but not easy”.
    Never confuse the two.
    Value investors sell, and yes they lose money – everybody does. Last time I checked, we were all human.

    Trying to learn or interpret value investing reading a bunch of buffet quotes is like trying to learn cricket watching highlights of a bunch of Sachin Tendulkar innings. It’s a great place to start.But it’s not going to make you Sachin, or even a half way decent batsman!

    So there you have it. Hope this made some sense.
    Remember, always tread your own path!

  • Deepak Shenoy says:

    >Mark: I think we're all saying the same thing: don't take Buffett's words at face value. The "Don't lose money" can't be taken as so, period.

    The problem isn't that he went back on what he said – everyone needs to do that in this world. Soros is famous for turning on a dime – he'll be long something with conviction and could switch to the short side when something changes. Even Keynes said, "When the facts change, I change my mind. What do you do, sir?"

    The problem is people who will not change their actions even when data changes. Like you said, holding on forever because that's what Buffett said – you don't do that, you exit when either you've reached where you wanted to go, or you're going in the wrong direction.

    On a technical note, if you are saying that he "did not" break that rule, then we must agree to disagree. His rules aren't all that's value investing is about – in fact what you've written makes more sense than the sound bites we get as quotes.

    I'm the first to say I don't know enough about value investing. Especially not when management can fudge their public statements 🙂 But yes, I tread my own path – it's a combination of financial analysis and price-volume. Even if we did argue about the relative merits of each, there has been an enormous amount of money made by proponents of either system, so let's hope we all make money!

  • jhantu says:

    >buy and hold is a concept that will no longer work in the US market, with HFT dominating volumes and trades slow moving institutional buy and hold players are now dinosuars …