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Want to Invest Like Buffett? Then Don't Buy BRK

Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I recently enjoyed reading an article by Jake Mann of Insider Monkey titled "Want to Invest Like Buffett?" The article makes several good points; it notes that Buffett likes to buy simple businesses that have durable competitive advantages and strong management teams. He then argues that it is difficult to know how to invest like Buffett, so we should just buy Berkshire Hathaway (NYSE: BRK-B) and call it a day.

That's not terrible advice, especially considering that Berkshire trades at a discount to what many investors believe to be its intrinsic value. On top of that, you get an outstanding CEO in Warren Buffett managing your money.

But I'll have to say, I was more than a little disappointed with Jake's conclusion. Sure, Berkshire might be a decent investment, but I don't think it's a stock Buffett would buy if he had only a couple million dollars to invest. I don't want to have rich old Warren manage my money and get rich old Warren returns. I want young and ambitious Warren returns.

Early Buffett: Net-Nets and Great Businesses

A much younger (and poorer) Buffett would not spend much time analyzing an enormous insurance conglomerate like Berkshire Hathaway. Instead, he'd be buying tiny, little-known securities that are so illiquid that I could get sued for market manipulation for posting examples here. However, suffice to say he would be buying either net-nets or great businesses.

Net-nets are the situations that Buffett's mentor, Benjamin Graham, made famous. A net-net is any stock trading for less than its current assets minus all liabilities. In theory, the company can liquidate and give shareholders a payout in excess of the current stock price. In other words, the market is saying the company is worth more dead than alive. The adage "good things happen to cheap stocks" is the investment thesis here. Buffett bought a lot of these "cigar butts" in his younger years and made lots of money doing it.

But Buffett also invested in great businesses. Long before Charlie Munger arrived on the scene, Buffett invested 75% of his portfolio in GEICO stock -- considered to be a growth stock selling at a fair price at the time. Charlie Munger's biggest influence on Buffett was not to start investing in great businesses, but to stop investing in net-nets.

Great businesses come in all shapes and sizes. I've found great businesses with market capitalizations under $15 million. The majority of great businesses have extremely large market capitalizations, but there is limited opportunity in these issues due to their wide followings. However, investors should understand why these big companies are great businesses so that they can go out into the nooks and crannies of the market and uncover great businesses that few have heard of.

Two Great Businesses

When you think of great businesses, you probably think of companies like Coca-Cola and Moody's. These are businesses that Buffett owns and loves. However, there are other models worth investigating to add to your knowledge of great businesses.

Take, for instance, Fair Isaac Corp. (NYSE: FICO). FICO owns a wonderful business -- credit scoring. Essentially, FICO gathers some personal information as an input, does some magic, and -- poof! -- a credit score!

As you can imagine, this is a high-margin business. FICO is the only company that can produce a FICO score. In addition, the company is finding new ways to monetize its special asset. Traditionally sold only to to lenders, FICO is now promoting myFICO.com, which allows members of the general public to purchase credit score information.

However, FICO also owns some poor businesses. You do not need to sit down with management for a one-on-one chat to know that free cash flow has not been used wisely in the past. Instead of returning all of the free cash flow produced by the wide-moat credit scoring business, management used shareholder money to invest in businesses that have no competitive advantages. This is a troubling indication of poor management that should be weighed against the strength of the credit scoring business in determining FICO's investment merits.

Dun & Bradstreet (NYSE: DNB) is another great business. Over the years, DNB has compiled a database of 200 million business records -- a feat that no new entrant could hope to replicate. This gives DNB incredible pricing power, which is clearly illustrated by its high margins. Lately, management has been taking on a heavier debt burden to leverage the remarkable consistency of DNB's profitability. Investors should be wary of too much debt, but a manageable load is nothing to be concerned about.

Never Stop Searching, and Don't Be Afraid to Hold Cash

At the end of his article, Jake says, "as investors, we understand the importance of not leaving cash idly sitting around. If you're struggling with ideas on where to put some of your investment cash in 2013, Berkshire Hathaway is a low-risk way to capitalize on long-term growth."

Again, Berkshire is a decent investment for the average individual investor -- the investor who wants to have somebody else manage her money in a safe and reliable manner. However, it's not a way to invest like Buffett.

To paraphrase Buffett, cash is a call option with no expiration date. Investors should not buy a stock just to be fully invested; instead, they should wait for stocks to get cheap and then exercise their right to buy.

Investors who wish to wish to invest like Buffett should stop researching Berkshire Hathaway and start looking at microcap companies that have durable competitive advantages. Look in the ugliest corners of the stock market, places where stocks trade maybe one day out of the month -- sometimes even less. Look at companies that are controlled by families; companies that are conservatively managed and that do not appear interested in optimizing debt ratios; companies that turn off most investors because they do not care what Wall Street thinks. This is where you will find opportunity, and it's where Buffett would be looking if he had to start all over again today.


titans8904 has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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