There’s a Side of Warren Buffett Most Investors Don’t Know About

Henry Truc  |

Warren Buffett has long been viewed as one of the greatestinvestors in history. His folksy and unassuming persona, espousing the virtues of traditional value investing is revered as gospel by most investors. While there’s no questioning the effectiveness of Buffett’s strategy in generating long-term returns, there’s another side of the Oracle and Omaha most people don’t pay attention to.

After all, being regarded as one of the greatest, if not the greatest investor ever certainly has its perks. An investment by Buffett and Berkshire Hathaway (BRK.A) also represents an unparalleled vote of confidence in the target company, and companies in dire need of market confidence are often willing to pay the premium price tag for it.

As The Wall Street Journal reports, Buffett and Berkshire are on the verge of losing an $8-per-second cash cow from Dow Chemical (DOW). The seven-year-old income stream (which equates to about $255 million per year) came from a $3 billion investment in Dow to purchase Rohm & Haas. In return, Berkshire received three million shares of preferred stock paying a hefty 8.5% annual dividend. But there’s a kicker.

“If Dow’s shares exceed $53.72 for at least 20 trading days in a 30-day period, the chemical company can convert Berkshire’s preferred shares into common stock, which pays a 3.4% annual regular dividend but no special dividend.”

Shares of Dow last closed at $53.61, which would be up about 750% from its low in 2009. But curiously, the company’s stock is only trading at a P/E multiple of 7.87, well below the average of 27.52 of its peer group. If Dow Chemical were to trade more in line with the P/E of its chief rivals, its stock price would be up around $187. This massive disparity in valuation has led to questions of whether Buffett is shorting Dow’s stock, essentially speculating that Berkshire would go so far as to manipulate the price in order to keep the money flowing in at the expense of Dow and its other shareholders.

But the Dow deal, and its generous terms for Berkshire, isn’t an exception for Buffett. In fact, as the WSJ pointed out, during the financial crisis from 2008 to 2011, “Berkshire shelled out roughly $25 billion for preferred securities of Dow Chemical, Bank of America Corp. (BAC), General Electric Co. (GE), Goldman Sachs Group Inc. (GS), Swiss Re (SREN) and Wm. Wrigley Jr. Co.”

Goldman Sachs was paying Buffett more than twice as much as Dow is now, averaging out to about $15-per-second on $5 billion in preferred stock yielding 10% annually, before the Great Vampire Squid was able to buy back the preferred shares in 2011. Of course, Buffett didn’t exactly make it easy:

"I'm going to be the Osama bin Laden of capitalism. I'm on my way to an unknown destination in Asia where I'm going to look for a cave," he joked. "If the U.S. Armed forces can't find Osama bin Laden in 10 years, let Goldman Sachs try to find me."

He employed similar tactics during the dot-com bubble as well, which Slate’s Daniel Gross pointed out in 2002. Buffett was utilizing tactics that were more representative of “vulture investing” rather than the value investing he’s made his reputation on.

“There's nothing inherently predatory about vulture investing. It's one of the iron rules of the marketplace that companies with poor financial prospects wishing to obtain capital simply have to meet more onerous terms than those with sterling balance sheets. But vulture investors, and others who specialize in distressed situations like Carl Icahn, tend to have sharp elbows, which means that common shareholders can get hurt when they move on a company.”

According to Gross, Buffett financed distressed companies like Level 3 Communications (LVLT) and Williams Companies (WMB) at fairly aggressive terms. Level 3 issued convertible notes with a 9% dividend, and Williams—according to Gross—accepted a one-year loan that cost an estimated 35% in interest and charges. That’s certainly a value investment if you can get it.

As Trade Like Warren Buffett author James Altucher so eloquently put it, “Everybody thinks Warren Buffett is like their grandfather. He’s kind of like older and cuddly, and then he gives advice every year with his letters to shareholders. But the reality is, Warren Buffett will slit your throat in a dark alley. He is not on the side of the average investor. He has never been on the side of the average investor and he never will be.”

While entertaining, Altucher’s point is debatable. After all, it could be argued that Buffett has done as much good as anybody for financial literacy and investment education. Still, it’s fascinating to see the darker side of Buffett every now and then when we get the chance.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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