How to follow Buffett’s buying spree the right way
Warren Buffett’s long-term track record is remarkable, but following him isn’t necessarily the best strategy. Whereas Buffett can afford to earn single digit returns on his big energy-related acquisitions, most investors and savers need higher total returns. Buffett’s railroads nor utility investments will never offer extreme equity-like growth private investors need.
Of course, Berkshire Hathaway Inc. (NYSE:BRK.A) also has a much lower cost of capital than you or I. Berkshire effectively borrows billions of dollars from its insurance subsidiaries at zero. I don’t know about you, but I certainly cannot raise billions of dollars to finance utility acquisitions with other people’s money with absolutely zero interest costs.
Here’s how you can follow safely and intelligently:
- Move fixed-income holdings to utilities – Utilities are a sound long-term bet, but they should be compared to fixed-income investments like bonds and preferred shares, not common stocks. Compared to fixed-income investments, the utility sector looks like a much more compelling value with substantially more upside. The Utilities SPDR (NYSEMKT: XLU) offers a yield of 3.84%, an impressive yield compared to the returns on 5- and 10-year investment-grade debt securities. Investors should not expect this portion of their portfolio to beat the returns on common stocks; however, utilities should deliver a combination of current dividends and dividend growth that provides income well above bond yields. Not to mention that utilities currently trade at a slightly lower earnings multiple than the broader S&P 500 index.
- Take another look at insurance – Insurance is an excellent business, and Berkshire Hathaway Inc. (NYSE:BRK.A) is proof of that fact. Insurance companies are trading at depressed multiples despite their leverage to investment returns. One of the best picks in the space is The Chubb Corporation (NYSE:CB) , which is known as a quality underwriter for its low combined ratio (the cost of business expressed as a ratio of percentage of premiums received), and for its excellent capital allocation. Trading at under 14 times last years’ earnings, the company trades at a discount to the S&P 500 despite its history of shareholder value creation. A dividend yield of 2% is in line with market averages. Moreover, the company excels at repurchasing its own stock, buying back 25% of its shares in just the past five years.
Investors shouldn’t follow Buffett blindly. Utility stocks aren’t priced for market-beating performance, but they should exceed bonds over the long haul. Likewise, Berkshire’s impressive insurance model may be fantastic, but other insurance companies like The The Chubb Corporation (NYSE:CB) orporation are still small enough to find good places to put their float.
These two investments offer a way to follow Buffett without sacrificing long-term returns.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway Inc. (NYSE:BRK.A). The Motley Fool owns shares of Berkshire Hathaway.
The article Buffett Puts His Money Where His Mouth Is originally appeared on Fool.com.
Jordan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
