Warren’s Way

Kai Sato

I GRADUATED FROM college in 2007, shortly before the economy was brought to its knees by the Great Recession. I worked in asset management for Macerich (symbol: MAC), a publicly traded real estate investment trust. During the panic, the company’s share price plunged from $92 to $5.

There was fear in the markets. You might even say mass hysteria. Our executives were mostly miserable because their stock options were underwater. Waves of layoffs ensued. Knowing the company’s balance sheet was relatively healthy, I began buying shares—although I didn’t have much money and I was pretty clueless as an investor.

What I didn’t know then was that 2008-09 would present one of the best investment opportunities of my lifetime. I’ve continued to invest, mostly following the advice of Warren Buffett and Charlie Munger, the chairman and vice chairman of Berkshire Hathaway. Along the way, I’ve made millions of dollars’ worth of mistakes—but I’ve also enjoyed some success and learned an awful lot.

Being raised in a family where money was tight—my parents had to file for bankruptcy—I root for people to invest well. I also agree with Buffett that most people should “consistently buy an S&P 500 low-cost index fund; keep buying it through thick and thin, and especially through thin.”

What if, like me, you feel compelled to actively manage your investments? I’d suggest following Buffett and Munger’s philosophy. Here are 10 rules I’ve distilled by studying their approach to investing.

1. Limit yourself to 10 “units.” “Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now,” says Buffett. “Over time, you will find only a few companies that meet those standards.”

Growing up, I was always told to diversify. If you’re going to actively manage your stock investments, that advice goes out the window. Good ideas are rare, and you should only invest in something if you’re willing to risk 10% of your capital, advises Buffett.

I take this literally, and imagine my portfolio as containing only 10 units. I’ll usually buy a pilot position and then scale up as my conviction rises. It’s not uncommon for a single position to be worth 20% to 30% of my portfolio.

2. Swing at your pitch and only your pitch. “The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot,” says Buffett. “And if people are yelling, ‘swing, you bum,’ ignore them.”

You must determine your pitch. Mine is to invest in small public companies that have undergone a management change and are demonstrating sound capital allocation, with the results starting to appear in their financial performance.

An example is Lattice Semiconductor (LSCC). A capable and motivated CEO, Jim Anderson, took the helm in 2018. He focused the company on a single market segment where it had a competitive advantage: low-power chips that can be reprogrammed. Demand for such chips was exploding, thanks to 5G, edge computing and the internet of things.

 Anderson also succeeded in revamping the company’s culture, with the employees committed to delighting the firm’s target customers. That’s started to show in its financial performance. When the markets plummeted in early 2020, I added significantly to my holdings. Shares were below $20 then; they’ve traded above $70 recently.

3. Bet more when your conviction rises. “The wise ones bet heavily when the world offers them that opportunity,” says Munger. “They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.”

I overlooked this one for a long time. I was content with a decent gain instead of adding more money to a winning position. It’s much like a poker game, where you raise your bet when you think you have the best hand. I now use a modified version of the Kelly Formula, which leads to heavier bets when the outcome looks auspicious.

One big bet I undertook recently was Atlas Corporation (ATCO). Atlas’s CEO is the former Berkshire Hathaway executive David Sokol, who’s fashioning Atlas into a mini version of his old employer. Unlike Berkshire, however, Atlas pays a decent dividend. I’d happily hold this stock indefinitely, but it’s likely being taken private by its largest shareholders.

4. Do lots of reading and learning—but not trading. “The real money is in the waiting, not the trading,” says Munger.

While my day job is building early stage tech companies, I commit the first 90 minutes of each day to value investing. I copied this from Munger who, when he was still practicing law, would dedicate the first hour of his workday to his investments.

I read, think and meditate. My actual transactions during this time are minimal. While there are some amazing traders out there, I’m not one of them. For me, this time is better spent revisiting key concepts from some of the best books about Buffett.

5. Be a contrarian and ignore most pundits. “It’s not enough to do the opposite of what others are doing,” says Buffett. “You have to understand what they’re doing; understand why it’s wrong; know what to do instead; have the nerve to act in a contrary fashion; and be willing to look terribly wrong until the ship turns and you’re proved right.”

Being contrarian suits me because I’m competitive and I like to reach my own conclusions. Companies are like puzzles. I enjoy reviewing financials, listening to earnings calls and scrutinizing shareholder letters. I like being an investment committee of one, where you make money when you’re right—and pay the price when you’re wrong.

6. Use your small portfolio to your advantage. “Clearly you run into companies that are less followed,” Buffett says. “There’s more chances for inefficiency when you’re dealing with something where you can buy $100,000 worth of it in a month rather than $100 million.”

Berkshire is too big to invest in smaller companies now. As an everyday investor, your investment universe is far larger. It takes in small- and micro-cap stocks—meaning companies with market values of less than $2 billion and $300 million, respectively. Companies this size make up more than half of the stocks listed on U.S. exchanges, yet they’re often out of reach of institutional investors.

7. Capitalize on market cycles but don’t time them. “Be fearful when others are greedy, and greedy when others are fearful,” Buffett famously advised.

I study market cycles in hopes of capitalizing on them. Howard Marks’s book, Mastering the Market Cycle, is an excellent overview of booms and busts, which are largely driven by credit—or the lack thereof. As legendary value investor Ben Graham taught us, Mr. Market will sometimes present us with great stocks at cheap prices. The key is to buy when others are petrified.

8. Leverage yield, especially “yield on cost,” over long holding periods. “Generate funds at 3% and invest them at 13%,” Munger advises.

Ideally, you’ll have at least one holding that returns your entire initial investment every time you receive a dividend payment. While it can take a number of years, you only need to find one or two of these in your investment career, as Buffett has demonstrated with Coca-Cola and American Express. Yet I’ve made horrendous mistakes around this principle.

My prescient grandmother bought 100 shares of Exxon for me in the mid-1980s, shortly after I was born. The stock split two-for-one in 1987, 1997 and 2001. The money was intended for my college education, but—thanks to academic scholarships—I was able to hang on to the 800 shares. Then, thinking that I was wisely diversifying, I sold half my shares in 2007.

At times, my mother and I relied on the dividend income to make ends meet. If that hadn’t been necessary, imagine what the position would be worth today if we’d reinvested all dividends and held on to all the shares—and how today’s annual dividends would compare to the original cost of the shares.

Regrettably, I made the same mistake again years later, selling a great stock, Innovative Industrial Properties (IIPR), far too early. Now paying nearly 40% of its initial purchase price in annual dividends, it would have been an incredible core portfolio holding.

9. Sell when the investment thesis changes. “We would sell if we needed money for something else—I would reluctantly sell something terribly cheap to buy something even cheaper,” Buffett says.

The ideal holding period is forever. But if you find a better use for your capital, or when the investment thesis changes, it’s likely time to sell. As I mentioned at the start, I bought shares of my employer, Macerich, during the Great Recession. I bought even more shares when they fell into the single digits.

The thesis changed when its largest competitor offered to acquire the company for $91 per share in 2015. The stock surged on the news and I sold my entire position. That was a significant premium for a business that I no longer wanted to own “forever.”

10. Judge your performance against the S&P 500. “If any three-year or longer period produces poor results, we all should start looking around for other places to have our money,” Buffett writes.

Value investing is hard. While Buffett and Stan Druckenmiller have produced incredible streaks of outperformance in their careers, even great investors have down years. A concentrated portfolio is prone to significant swings and may show paper losses. Buffett’s test is to compare your long-run returns to the S&P 500. If you aren’t able to beat it, it’s probably wiser to index.

Kai Sato is the founder of Kaizen Reserve, Inc., a venture capital advisory firm for corporations and family offices. He recently served as the co-president and chief marketing officer of Crown ElectroKinetics (CRKN), a smart glass technology company that combats climate change. Kai is also a fund advisor and the former entrepreneur-in-residence at Hatch, a global startup accelerator focused on helping feed the world through sustainable aquaculture technologies. He’s the author of “Marketing ArchitectureHow to Attract Customers, Hires, and Investors for Any Company Under 50 Employees.” Follow Kai on Twitter @KaiDaywalker.

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