June 17, 2013 - How small investors can trade like Buffett
When it comes to investing, one of the most powerful tools investor can have is size. When an investor owns a significant amount of shares in a company they definitely have an advantage over smaller investors in a number of ways.
This idea is best understood by looking at Warren Buffett and the holdings of his company Berkshire Hathaway. His company is so large, that when he wants information on a company he can simply pick up the phone and place a call to the company's CEO. This is a luxury that 99% of investors do not enjoy.
We are forced to rely on news coming down the pipeline before we are able to take advantage of it, and by that time it is often too late.
Buffett also has the ability to influence the decisions of a company's board of directors. If he feels that a company is headed in the right, or wrong direction, he can make public statements that will influence the direction of the company. Once again, other than casting proxy votes we have little influence over the way a board of directors acts.
The good news is that even small investors can take advantage of the leverage that Buffet has built over the year. For one thing, Buffett is forced to disclose what stocks he invests in. Traders are able to track his moves and replicate them in his or her own portfolio, but by the time that news is available it is often too late.
One way that you can take advantage of his investment skill without having to do too much homework is with an investment in Berkshire Hathaway Inc (BRK.A), (BRK.B). BRK.A shares are more than $170,000 each, so for the purposes of this article, I am going to keep my focus on the more reasonably-priced, non-voting BRK.B shares, which are just above $100.
There are both advantages and disadvantages to investing in Berkshire Hathaway. The obvious advantage is that you get to take advantage of Buffett's investment skill despite how big or small your portfolio may be. Companies that Buffett invests in tend to be solid performers, and you get to enjoy their upside along with the Oracle of Omaha himself.
Another advantage is that you do not have to worry about trading a particular stock that Buffett owns and risk downside selling when Buffett exits his position. Like with stocks he buys, by the time you get the news that he has exited a position the damage is likely to have already occurred.
The disadvantage is that companies in which Buffett invests are not the type of companies that are going to make sharp moves higher. His style looks for slow and steady long term growth, and that has to be your investment goal if you want to trade Berkshire stock.
If you are willing to accept a steady, slow growth in your investment, then BRK.B is a great way to tap into Buffett's trading skill and power for your own benefit.
While his investments tend to be winners, there is always the risk that things can go the wrong way, and that is why I would prefer to take a hedged approach to trading BRK.B.
A good hedged trade on Berkshire Hathaway BRK.B is the September 100/105 bull put spread for a credit of 40 cents. To set up this trade, you will sell the September 105 puts, while buying the same number of September 100 puts for a credit of 40 cents. This trade has a target return of 8.7%, which is 32.1% on an annualized basis (for comparison purposes only), and has 7.8% downside protection.
Chart courtesy of stockcharts.com