Tags: Buffett | stocks | beta | leverage

How to Invest Like Warren Buffett

Tuesday, 03 Dec 2013 12:51 PM

By Michael Kling

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Warren Buffett's renowned investment success is due to leverage as well as great stock picking, according to research by the National Bureau of Economic Research.

The paper sheds new light on Buffett's stock-picking ability. The chairman and CEO of Berkshire Hathaway is well known for his ability as a value investor, but his use of leverage is hardly mentioned. The NBER researchers estimate Buffett's leverage is about 1.6 to 1 on average.

"Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks," they wrote in the paper "Buffett's Alpha."

Editor’s Note: 5 Phases of a ‘Retirement Heist’ Exposed (See Video)

Berkshire Hathaway's publicly traded stocks perform better than its wholly owned private companies, suggesting that Buffett’s returns are more due to stock selection than to his effect on management, the researchers found.

"These results have broad implications for market efficiency and the implementability of academic factors."

The research also means ordinary investors will have a hard time matching Buffett's returns. They may be able to pick good value stocks with growth prospects, but they probably can't borrow as cheaply as Berkshire Hathaway, writes Sam Ro for Business Insider.

The paper says Berkshire has benefited from a AAA rating. It issued the first ever negative coupon security in 2002, a senior note with a warrant. Berkshire also finances part of its capital expenditure using tax deductions for accelerated depreciation of property, plant and equipment, allowed under IRS rules.

"Berkshire’s more anomalous cost of leverage, however, is due to its insurance float," the researchers stated. "Collecting insurance premia up front and later paying a diversified set of claims is like taking a 'loan.' We estimate that 36 percent of Berkshire’s liabilities consist of insurance float on average."

Bloomberg columnist Matt Levine asserts the paper is publicity for AQR Capital Management LLC, the quantitative hedge fund that employs the paper's authors.

The paper finds that you replicate Buffett's returns with 1.6-times leverage and a statistical investment approach that overweights high-quality companies with low betas, he writes.

"So that is interesting, I guess, if you like robots. It is also great advertising for AQR obviously, though they'd need to go match Buffett for the next 40 years before anyone would entirely believe in their robot-building skills."

Editor’s Note: 5 Phases of a ‘Retirement Heist’ Exposed (See Video)

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