Do Retail Investors have an Edge Over Warren Buffett?

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19 Jul Do Retail Investors have an Edge Over Warren Buffett?

Warren Buffett, the sage of Omaha, the world’s richest man, the most famous value investor of this century. As an investor, he has everything going for him – the network to tap on, a cheap source of funds to invest in and the investing know how.

His investment holding company Berkshire Hathaway has an enviable track record, pulling in approximately 20% returns per annum for the past 50 years.

However, the larger the company grows, the faster he is losing his ‘winning’ advantage. An advantage that retail investors like you and I have – the ability to make huge returns.

Maintaining a 20% return of investment becomes tougher for Warren Buffett

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For a small investor with a $100,000 account, a gain of $50,000 would be a 50% return. Whereas for Buffett who is dealing with billions of dollars, a $50,000 gain would be less than a 1% return.

And, he admits it too when he said:

“It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” – Warren Buffett in Businessweek, 1999

and…

“If we’re going to buy 5% of a company, to make that purchase worth 1% of Berkshire, it has to be a $2 billion company … and if the stock doubles Berkshire makes 0.5%.”– Warren Buffett in CNBC, 2015

Why does Warren Buffett find it difficult?

Although Warren Buffett could get high returns with a smaller investment fund, his current fund has grown too large for him to replicate the same system he used previously.

In the past, he could easily identify small, undervalued companies that he could buy a small stake of. Even Buffett has admitted that the ability to play in the world of small companies is more enticing compared to that of large companies when he said:

“The universe I can’t play in [i.e., small companies] has become more attractive than the universe I can play in [that of large companies]. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in.” – Warren Buffett in Businessweek, 1999

Now, if he were to invest using the same percentage of investment fund, he might end up as the owner of the company. And that is ultimately something that he wants to avoid.

After all, one of his philosophy is simply to identify undervalued companies, invest in them and stay out of the company’s management and operation matters. Buying over a company would go against that philosophy.

He could work harder to dig out many more undervalued companies to invest in. However, there are some issues with this strategy.

First, there may not be enough of these types of companies that will pass his acquisition criteria.

Second, buying stocks in too many companies may lead to the over diversification of his portfolio which is something that Warren Buffett has also been known to avoid.

Lastly, companies that are successful and have grown in size attracts the attention of the media, analysts and institutional investors. Price discovery is high and it is difficult to find value amongst this universe of stocks.

But as retail investors, we have the very advantage that Warren Buffett has lost

Compared to Warren Buffett, retail investors lack the knowledge, network and time to research deeply into every potential company. Thus we are unlikely able to beat the S&P index (or any other index) consecutively for many decades. Most of us will be better off investing in a fund that tracks the index.

On the other hand, retail investors can invest in companies that are small, relatively unknown and hence undervalued by the market. Many of these companies are engaged in stable businesses with good earnings. Retail investors would only need to invest in a few in order to get good returns. We are not faced with the same set of problems Warren Buffett faces.

Hence, the opportunity for high returns remain wide open to smart and savvy retail investors who are willing to put in their time and effort to look out for undervalued companies.

image: business2community



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