Not logged in. Login | Signup

A safer way to buy individual stocks

2019-11-12, Michael Thompson

Share on facebook Share on twitter

Become an insider
Get the latest updates.

A safer way to buy individual stocks

In this article, we discuss safer ways to buy individual stocks. Unless your education, passion, and career are devoted to it, buying individual stocks can be very risky. However, many of us can't resist the urge to set aside some money for individual stock picking. If we're going to do it anyway, let's talk about a safer way to do it.

This method leverages the research and wisdom of experts, e.g. Warren Buffett at Berkshire Hathaway. Buffett is well known for only buying stocks if he (1) understands the business, (2) believes it's reasonably priced, and (3) is willing to own it for a very long period. Many experts share this philosophy, but few have the patience and emotion to execute it as well as Berkshire.

The Strategy

Institutional investment managers with over 100 million USD in equity assets must disclose their US equity holdings quarterly, in SEC Form 13F. This gives us a free look at what people like Buffett have held, purchased, or sold. We'll start with this list of stocks, and down-select from here. We'll refer to Berkshire/Buffett below, but you could apply this logic to Oaktree/Marks or other institutions/individuals you have high confidence in.

The first down selection will remove all stocks in which Berkshire’s holdings have decreased since the previous 13F filing. If Berkshire/Buffett is selling a stock they may have identified problems, and we don’t want to risk buying such stocks.

We’ll also remove stocks that have appreciated significantly more than the S&P 500 in the prior 4 months. These stocks may have been a good deal when Berkshire purchased them, but they are at a higher risk of being overpriced now. Berkshire may have even sold some of these recently—we can’t see what Berkshire has sold after the cutoff date in their latest 13F (which could be months ago).

We also want to remove stocks that have appreciated quickly after Berkshire’s filing. This could indicate an excess of people applying a similar strategy and effectively overvaluing the stock. The 13F filing includes a “filing date” you can use for this purpose.

At this point, you should have a list of over 20 stocks to choose from. They are less likely to fail than the average company and should perform significantly better in a recession, on average. Admittedly, in the case of Berkshire, they probably aren't "sexy" and are unlikely to generate massive returns. Some further information is provided below.

There's a significant thing we should mention here. The SEC sometimes grants exceptions to 13F disclosures. For example, Berkshire's purchases of IBM were not revealed in 13F filings. Often, when the big-name investors are buying into a position with high conviction, they will request (and often receive) this exception. Unfortunately, we'll miss these opportunities with this strategy.

Low Risk = Limited Upside

As usual with investing strategies, increased safety comes with a drawback: limited upside potential. We said Berkshire only buys stocks of businesses they understand. There will be (or are now?) businesses that will grow into the next Microsoft or Apple. Unfortunately, such companies will likely be based on novel technologies outside Berkshire's domain of expertise. Don't expect to capture these big prizes with this strategy.

Limit exposure to any one company

Even though this strategy will limit you to safer companies, we still don't recommend putting more than 30% of your savings into one company. Warren Buffett would be the first to admit that even he makes mistakes. If you invest long enough, you're going to buy something that loses most or all of its value. If too much of your capital is in that asset, it can be devastating.

When to Sell

13F forms are typically filed over a month after the end of the quarter, and they do not disclose any information after the end of that quarter. This means there can be months of delay between when a company like Berkshire sells stock and we find out. At some point, their analysis will indicate that the underlying business is no longer attractive (or at least that others are more attractive). If Berkshire sells stock on the first day of a quarter, we won't know for almost 5 months! So what do we do?

Of course, if you see a new filing that indicates they've sold, but the price hasn't dropped significantly yet, you've got a nice chance to escape. Barring extreme circumstances, we like to hold our stocks for at least a year. After that, we recommend re-applying the strategy above. Take the down-selected list and evaluate which companies you'd like to buy. Compare your choices with your current holdings and sell/buy accordingly.

Login to leave a comment.

Related Articles

Should you try to beat the market?

Buffett's bet on index funds

Investing Basics: A most concise guide

Click here for a list of other recent articles.