Those were the questions a nervous gentleman asked the Sage of Omaha towards the end of the 2006 Berkshire Hathaway shareholders meeting — which I attended with my colleague Chris Mayer.

Buffett didn’t waste much time answering. If he were a retail investor these days with a limited budget he would sock his money int

1)    Smaller companies that the major institutions (including Berkshire) can’t even think about investing in because they are too small.

2)    Emerging markets where you can buy great businesses for next to nothing.

Buffett’s affinity for obscure, out-of-the-way investment opportunities (i.e. small-cap stocks) is well documented.

In 1999 he told Business Week “…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.”

And in a 2005 interview with a group of students at Kansas University, Buffett defended that statement saying:

Yes, I would still say the same thing today…You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map – way off the map. You may find local companies that have nothing wrong with them at all…

Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.

To illustrate his point, Buffett told the 24,000+ people who made the trek to the Quest Center this weekend that he would have put 100% of his assets in South Korea a year or two ago when incredible companies (many small-caps) were selling for three or four times earnings. But because Berkshire is a massive $112 billion company, he couldn’t take advantage of the opportunity. The companies were too small and too illiquid for them add to Berkshire’s earnings power. So he had to sit and watch.

As a small investor, you don’t have to sit on the sidelines. You can take advantage of the illiquid opportunities that the big-boys, like Buffett, simply can’t. But as Warren reminded everyone (as he sipped on his Coca-Cola and ate his Sees’s candy), just because he would love to invest in smaller companies doesn’t mean he would change his underlying strategy. He still wouldn’t speculate in companies he didn’t understand.

That comment got people in the audience thinking about their own investment ideas and strategies.

One shareholder asked, “What is your opinion on ethanol? Should I look at those companies now?”

Buffett responded by saying, “I have friends who like ethanol. And I have friends who don’t like ethanol. I’m sticking with my friends.”

He explained that ethanol might well be an adequate investment idea. But the fact is, no one knows what an ethanol plant will be producing in five years. The economics of the business could totally change over that time. And that uncertainty scares him – so he won’t invest. Plus, he made it a point to say, “Ethanol is hot right now. Our general policy is not to look at things that are hot.”

Then the next question came, “Are we in a commodities bubble?”

“My guess is we’re seeing speculation in commodities and the housing market today,” Buffett said.

So the next shareholder dug a bit deeper. “What kind of exposure do you have to silver?”

Warren explained that he has no exposure right now. He got into silver early in the game — when the fundamentals make sense to buy. But he admits that he sold very early as well.

Buffett made the point that silver (like oil and all commodities) isn’t an interest bearing investment. In other words, in order to make money in silver you have to hope (something any value investor doesn’t like to do) it rises. If it doesn’t, you are better off putting your money in stocks or bonds.

Not wanting to leave the area of commodities, one annoying shareholder (who’s piercing voice blared through the speaker system at a decibel level that may have deafened some) asked if investors would be smart to invest in countries where there is an abundance of natural resources per capita.

Buffett responded by saying, “We don’t play big trends. That’s too macro for us.”

And Charlie Munger finally chimed in to end this big-picture discussion by saying, “We failed to profit from the recent commodities boom.”

Everyone laughed.

Of course, being a value investor means you don’t catch every wave.

When you insist on buying companies at cheap prices and selling when they are no longer cheap, you inevitably buy early and sell early. In Buffet’s case, that’s what happened with silver. And a lot of the times, they miss opportunities altogether. The classic example is technology.

Buffett never invested in tech stocks in the 1990s. And he still doesn’t regret it. As he explained to the crowd, we know what we are good at and we stick to those things. In the Olympics, you can win a gold medal if you can run 100 meters faster than anybody. You don’t have to throw the shot-put as well.

The same is true in investing.

You don’t have to get everything right. You just have to know what you do well and stick to that. In Buffett’s case that means staying away from tech and commodities.

Here at the Sleuth headquarters, we think that is good advice. 

We know about small-cap companies with solid fundamentals, insider buying and growing top and bottom lines. So while everyone else is speculating in housing, commodities, options and futures, we’ll just stick to what we do best and not worry about the rest.

It worked out all right for Buffett.

Yours from Omaha,

James
May 11, 2006

Why Buffett Wishes He Could Invest Like You was originally featured in the Penny Sleuth.