Warren Buffett is an investing genius. In fact, you may also know him as the “Sage, Wizard, or Oracle of Omaha.” He is the primary shareholder, chairman, and CEO of Berkshire Hathaway (NYSE:BRK.A).
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Financial advisers want to emulate him and investors want to work with him. Heck, even I wouldn’t pass up the opportunity to sit down with Buffett and pick his brain.
The elite few who are shareholders in Berkshire are very lucky (and rich), because they have to pay a fortune to gain access to Warren Buffett’s market-beating gifts. For just one share of stock, an investor will have to pay approximately $170,000. To generate a profitable return, that investor would need to invest millions.
Obviously, not everyone has this kind of money, but that doesn’t mean that the average investor still can’t create their own “Buffett portfolios.” And I’ve got three golden rules as to how you can do it without the high price tag.
1. Buy what Buffett buys and aim to “hold forever”
Berkshire Hathaway is built around the idea that everything Buffett picks can go on beating the market after he’s dead and gone -- and that quality doesn’t go away just because you’re only following his picks from afar.
Buffett chose a lot of these names decades ago and is unlikely to exit any of them without an external catalyst to force his hand. In fact, as of March 31, 2013, funds at Warren Buffett's Berkshire Hathaway were valued at $85 billion and included 41 total positions.
However, simply cloning the weightings that produced that result would still require about $165,000, in order to give big names their due, while leaving room for a single share of tiny holdings like Lee Enterprises (NYSE:LEE), with a market cap of less than $90 million.
At that level of initial buy-in, you’d be better off scraping up another few thousand dollars for BRK itself and gaining exposure to GEICO and other wholly-owned businesses you can’t access on your own.
But even if you shifted to an equal-weight 40-stock portfolio, it would mean building the positions in $3,600 increments, which may still be a little rich for the typical IRA.
Stripping down the allocation cheapens the initial ante but sacrifices “alpha”(i.e., a measure of performance versus a benchmark index) the leaner you go.
And you, too, can go lean. At the lower limit, someone who spent just $350 for one share each of Buffett’s four biggest holdings -- Coca-Cola (NYSE:KO), American Express (NYSE:AXP), IBM (NYSE:IBM) and Wells Fargo (NYSE:WFC)–would have under performed the S&P 500 by 1 percentage point so far this year.
2. Pick proxies for the private equity
While Berkshire’s public portfolio has beaten the market, passive investments actually contributed only 37% of Berkshire Hathaway’s total gross earnings last year and may reflect only around half of BRK’s 27.0% YTD return.
The real “secret sauce” is derived from the constellation of captive businesses Buffett didn’t want to share with every other investor out there -- so he bought up all the shares.
Railroads and diversified industrials are the biggest components of the operating pie, accounting for about 23% apiece of the overall company.
Although Buffett loves his GEICO, insurance underwriting only brought in 8% of his profits. So did the utilities, while the mortgage and equipment leasing arms together weigh in at a slim 3% of the whole.
Of course, nearly every company Berkshire owns has a direct competitor, or at least a rough proxy trading the public market, so it’s possible to create a portfolio offering similar exposure to similar businesses throwing off similar cash flows.
Either way, you don’t have to get too granular. For the “manufacturing” segment – which includes everything from cable to candy – an ETF like the industrial SPDR XLI offers fair place to start, while KIE or IAK provide the equivalent exposure to the broad insurance group.
And you might turn up some surprises. Railroad operator CSX Corp. (NYSE:CSX) has soared 25% so far this year but is still trading at earnings multiples below both BRK and the S&P 500, so there seems to be room left here to keep moving.
Drill down as far as makes sense given the size of your portfolio and see how the results add up. Once again, the goal here is to find investments you’d be comfortable owning forever – but if you can’t find them, be patient.
3. Try a “bums of Berkshire” approach
Buffett traditionally only sells in order to free up resources to buy something he likes even better. Under the “hold forever” doctrine, the old holdings haven’t necessarily deteriorated. He simply no longer has room on his plate for them.
Four companies that vanished from the Berkshire Hathaway balance sheet late last year were:CVS Caremark (NYSE:CVS), Dollar General (NYSE:DG), Ingersoll-Rand (NYSE:IR) and the former Kraft Foods international unit Mondelez (NASDAQ:MDLZ).
Buffett hadn’t fallen out of love with the companies, he just wanted to free up some cash to grab a piece of John Deere (NYSE:DE) and a few smaller manufacturers.
It took the “disgraced” charts a few weeks to recover, but now, on average, they’re beating the stocks left in Berkshire’s stock portfolio by a slim margin YTD.
So what should you do? Pick up the names Buffett needs to drop, hang on to those names, and even you have a chance to beat the master.
Berkshire liquidated stakes in six companies in 2011. One was acquired outright and taken private, but the other five are still publicly traded. These are big names, global brands, as high-quality as the Sage could ask for: Bank of America (NYSE:BAC), Comcast (NASDAQ:CMCSA), Fiserv (NASDAQ:FISV), Lowes (NYSE:LOW) and Nike (NYSE:NKE).
It turns out that this group has delivered double the S&P 500’s performance since the first session of 2012 –topping even BRK by a healthy 18 percentage points in the process.
Follow these three steps and you just might be able to create a portfolio as strong as the “Wizard of Omaha” – but without the huge cost.
Hilary Kramer is the editor in chief of the subscription newsletters: Game Changers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return Portfolio and Inner Circle. Formerly, Hilary was the CIO of a $5 billion global private equity fund. She has an MBA from the Wharton School at the University of Pennsylvania and began her Wall Street career as an analyst at Morgan Stanley. Hilary is the author of The Little Book of Big Profits from Small Stocks (Wiley) and Ahead of the Curve: Nine Simple Ways to Create Wealth by Spotting Stock Trends (Free Press). To learn more about Hilary Kramer visit: http://GameChangerStocks.com.