How to Learn From When Buffett Sells

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We're gearing up for the 2012 Berkshire Hathaway Annual Meeting. I'm here today with chief equity strategist, Paul Larson; he is also the editor of Morningstar StockInvestor. We'll take a look at Warren Buffett's sell strategy and if it makes sense for individual investors to adopt the same strategy.

Paul, thanks for joining me?

Paul Larson: Thanks for having me.

Glaser: So, Warren Buffett wrote in his letter this year and he has talked several times before that often there are businesses that might not be his favorite anymore or things have really fallen out of favor, but he chooses not to sell them for whatever reason. Could you talk a little bit about his thought process when it comes to almost never exiting the investment?

Larson: When you're looking at the private businesses that Berkshire owns, where they are going to own the businesses in their entirety, Berkshire is going to have a different strategy with those businesses than it is with the publicly traded securities that it also owns. So, maybe we can segment into two areas.

Regarding the private businesses that Berkshire owns in their entirety, its strategy there is to almost never sell. And the reason for that is Berkshire views that as a competitive advantage when it is going out and actually buying the businesses because the pitch to the business owners when Berkshire is looking to buy a business is that if you've created this business over a long period of time, many decades in many instances, and you are looking to potentially sell it, you want to make sure that you're handing that business over to someone who is going to act as a very good steward of that business.

And Buffett has said that Berkshire Hathaway is a fantastic home for these businesses, and Berkshire not going to act like a lot of other private equity shops and go in and basically maximize the amount of cash that they can extract from the business. They are basically going to leave the business alone, let the checks get sent to up to Omaha, Neb., so to speak, and that's pretty much all that they are going to do.

So, Berkshire's strategy, again, with the private businesses is to almost never sell even though as you pointed out, some of those businesses, perhaps such as some of the newspaper investments or some of the other consumer-related investments that were made 20 or 30 years ago, have not worked out and probably would be sold if Warren Buffett had the opportunity.

Glaser: But they are small enough to the general-picture Berkshire Hathaway, that he feels like the reputational effect of selling would be worse than necessarily the small cash gain he might get from exiting the business?

Larson: Exactly, because if Berkshire were to exit the business maybe it might save $5 million or $10 million in value by doing that. But then that is going to hamper the firm on their future returns, which are potentially much larger.

Glaser: So, most individuals aren't out there buying and selling private companies, but they are up buying marketable securities. Obviously, Berkshire has a relatively big investment portfolio. What Buffett's thinking around those, kind of, investments? How does he decide when it's time to exit?

Larson: Well, those particular investments are actually run both by Buffett as well as investment managers. He started to hand the reins over to Ted Weschler as well as Todd Combs, and it's been that way for awhile where there has been multiple people that have been running those publicly traded portfolios. But regarding those investments, he still has a very long-term outlook, but the managers are willing to trim those investments once they hit a valuation that the managers deem appropriate for selling.

So, you are going to get higher turnover in that publicly traded portfolio, but it's still very low turnover, somewhere around 10% or something like that.

Glaser: So, then what's the lesson for people who are managing much smaller amounts of money and who don't have the insurance float that that's been obviously spun off by Berkshire? What makes sense for a holding period? When should investors know to either cut their losses or take their gains off the table?

Larson: I think that there is certainly value in having a long-term perspective because it does force you to focus on the things that are indeed most important in the investment. That is the long-term competitive positioning and how much cash the business is going to throw off over long periods of time. Those are the things that you get focused on when you have an investment horizon that is quite long. You're not worried so much about the next quarter's earnings and whether the company is going to beat or miss by a penny. And I think the real lesson is that there is value in having that long-term perspective.

Glaser: Paul, thanks so much for your thoughts. We're looking forward to hearing from you on Saturday, May 5 at the Berkshire meeting.

Larson: I am looking forward to going again.

Glaser: For Morningstar, I'm Jeremy Glaser.