Sunday, March 24, 2013

03/24/2013 Be[ating] Buffett

Sector Model
Large Portfolio
Sector Model
Large Portfolio


Replacing the CASH position with TA.TO (TransAlta Corp.) in the POWER industry.

When I sold TTM last week I was up just shy of 4%.  It dropped 10% this past week, so CASH didn’t do so bad.

The technical configuration of the market has improved, with the model showing a 70% net long recommendation. 

BBRY took another hit.  Two steps forward, one step back.  What a crazy ride this one has been so far.

Okay, back to Buffett (and the subject of this post): “Be[ating] Buffett”:


Some folks had questions about how Buffett avoids dividend taxes, so I’ll have to quote his explanation from his book of Essays.

That link is to the 2013 edition.  I’ll be quoting from the 2001 edition, page 269:

“There’s a powerful financial reason behind Berkshire’s preference [to acquire 100% of a business rather than a small fraction], and that has to do with taxes.  The tax code makes Berkshire’s owning 80% or more of a business far more profitable for us, proportionally, than our owning a smaller share.  When a company we own all of earns $1 million after tax, the entire amount inures to our benefit.  If the $1 million is upstreamed to Berkshire, we owe no tax on the dividend.  And, if the earnings are retained and we were to sell the subsidiary – not likely at Berkshire! – for $1 million more than we paid for it, we would own no capital gains tax.  That’s because our ‘tax cost’ upon sale would include both what we paid for the business and all earnings it subsequently retained.

“Contrast that situation to what happens when we own an investment in a marketable security.  There, if we own a 10% stake in a business earning $10 million after tax, our $1 million share of earnings is subject to additional state and federal taxes of (1) about $140,000 if it is distributed to us (our tax rate on most dividends is 14%); or (2) no less than $350,000 if the $1 million is retained and subsequently captured by us in the form of a capital gain (on which our tax rate is usually about 35%, though it sometimes approaches 40%).  We may defer paying the $350,000 by not immediately realizing our gain, but eventually we must pay the tax.  In effect, the government is our ‘partner’ twice when we own part of a business through a stock investment, but only once when we own at least 80%.”

I cannot stress enough how important it is to read the entire book cover to cover – twice.  It gives an entirely new light on the balderdash of “please tax me more” he keeps shouting for the news cameras.

Imagine you were playing a game, where your back is to the sun and it cannot affect you – but it can blind your competition.  The sun, which does nothing DIRECTLY to you, still works in your favor by suppressing the competition.

Warren Buffett has his back to the blinding rays of the tax man.  And those rays are aimed straight at us.  It is entirely in his interest to have that light ramped up as bright as possible.

Warren Buffett should be read, studied, and emulated.  He should not be dismissed, and he should not be worshipped.

He should not be “whale watched” either.  Whale watching is that bad habit of buying stocks just because some successful guy owns them.  You’ll just pump up his stocks without necessarily doing anything for yourself.

So, let’s take a look at higher taxes to see how they HELP Warren Buffett:

1) They suppress his competition (pretty much anyone who is not big enough to buy entire companies as he describes above).

2) They suppress volatility.  Volatility is exacerbated by the short term flipping of stocks.  If short term traders have a 43.8% hit on capital gains, they will VERY QUICKLY lose their firepower, and will have a diminishing effect on the market.

3) They suppress momentum trading (typically short term and pro-volatility as well).

So, what does that leave?

It leaves long term value investing with a greater competitive edge than it used to have.

Therefore, taxes HELP Warren Buffett.

And this leads me to the next part of this post:


We can observe Buffett’s so-called fourth law of motion, which I’ve paraphrased to “the more you trade, the less you have.”

We have to consider the effect of taxes as obsessively and as skillfully as Warren Buffett.  We have to IGNORE what he says in the news about taxes not being an issue, and instead read his essays to see just how important tax avoidance is to successful investing.

We have to look for long term value and short term cheapness.

We have to think in terms of years, and not weeks or months.

We have to get a sense of what a company is worth, and see investment as owning a piece of a COMPANY instead of owning a piece of PAPER.  We aren’t buying a “stock”; we are buying as much of a “company” as is reasonable for our own net worth.

In other words, the first step in “Beating Buffett” is learning how to “Be Buffett.”

The greatest lesson I ever learned about investing came from my grandfather.  Ever since 1996, my grandfather has beaten the pants off of the market.

What did he do?


And I mean, ABSOLUTELY nothing.

My grandfather passed away in 1996.  I’d give anything for another game of Uno with him.

I can’t play Uno with him, but I can let him hold my hand when I invest.

When he bought companies, he bought companies that would still be around when he was gone, and year after year my grandmother was “advised” to flip her stocks, but she refused, and let my grandfather’s long term stock picking keep her steady.  She even had to sign wavers because her “advisors” didn’t want to be responsible for holding companies for so long!  Years run into decades, but some companies and industries are set to outlast even the youngest of us.

Invest as if you won’t be around to “flip” the stock if the company or industry turns sour.

It takes homework and fundamental thinking.

In short, it takes a different perspective.  A simple switch, but not an easy one.

The homework of learning fundamentals is not as complex as the plethora of technical tricks out there.  The key is that it takes more time BEFORE you buy a stock than technical tricks do.  But it takes less time AFTER you buy the stock, because you aren’t obsessing over every tick of the price 18 times a day.

Simple – but not easy: because people are not geared to work BEFORE they get something.  We’d rather buy something on credit than save for it.

Another switch is to focus on the value of the company instead of the price of a stock.  If the price is plummeting, but the long term value of the company is not greatly affected, the stock has gone on sale.  You may buy it and watch the price plummet ANOTHER 50%.  But if you look at the value of the company instead of the price of the stock, you’ll be able to do another thing that’s “simple, but not easy.”

We aren’t geared to work BEFORE we buy, and we aren’t geared to be punished AFTER we buy.

And if we do these things – if we try to “Be Buffett”, then we can “Beat Buffett” – not by winning any money from him (he doesn’t sell, remember?), but rather by NOT losing any more money to him than we already have, and by NOT falling prey to Buffett’s “business partner” (the tax man) who wants to suppress our ability to compete.

In the next few posts, I’ll talk a bit more about some specific fundamentals, and the only real ratio we need to focus on.

But this is enough for now…







  1. XLU seems still stronger than XLI since the March 8 switch, can you add the XLU performance for comparison on the tracking portfolio printout?

    By the way, what prices/dates are you using for 1.86% return for XLI? March 22 close was $41.62, March 8 close was $41.82, which is -0.48%

  2. Good catch.

    The model actually had some whipsaws from 2/25 through 3/6.

    It SHOULD only be up about .97% from the 3/6 (latest) entry, but I missed one of the whipsaws and picked up a partial % by accident.

    But that's not very trackable, so I should just put in the gain from the 3/6 end of day entry point. I'll fix that on the reporting.

    That would make everything consistent, since that's how I already track the stocks on the full model.

  3. Thanks, Tim, didn't realize the switch was actually March 6 since it was reported EOD Friday March 8 if I'm not mistaken. Also, if you can, it'd be great to see the opposite instrument return displayed for comparison (since the switch date).

  4. I'll have to do more "realtime" reporting on the sector model. To be honest, even though I'm running it live in a small account, it's only a benchmark for the full model. If the full model underperforms, then the fundamentals aren't working properly with the technicals.

    In any case, the sector model had some whipsawing:

    (all of these are end of day)

    2/25 XLU -> XLI
    2/27 XLI -> XLU
    3/1 XLU -> XLI
    3/5 XLI -> XLB
    3/6 XLB -> XLI

    Total returns with the whipsaws is 5.84%.

    Total returns if you just stayed in XLU is 5.75%.

    I've been planning to just report on the blog at the end of the last trading day of the week to spare people whipsaws that only have marginal advantages. The "loss" shouldn't be that much different from the trading costs a person would save, and he'd only have to peek in around 3:45 each Friday (or today, for this week) to see if there's a change.

    I have a friend who asked me to report it that way so he could follow it in his cash account, and it made sense to me.

    Since cash accounts have to hold a trade for three days, that works for him.

  5. Since 3/6, XLU is eating XLI alive... that's why I was interested in side by side comparative performance for the currently held segment.

  6. Sometimes that happens :-)

    Incidentally, the sector model may flip to XLB before the close. I'll post before 3:50 if it flips.