Berkshire Hathaway CEO Warren Buffett at the trade show during the company’s annual meeting in Omaha, Nebraska, on May 3, 2014. Photo: Rick Wilking/Reuters

Over the years I have written various articles about Warren Buffett. He is the chairman, CEO and the largest shareholder of Berkshire Hathaway and is given a lot of media attention since he is widely considered to be among the most successful investors of all times ranking consistently among the world’s wealthiest people.

Warren Buffett is normally given media prominence when he carries out some major acquisition or when one of his famous phrases is used by a journalist to explain the state of the stockmarket.

However, last month, he grabbed the business headlines for the wrong reasons as a number of companies in which he has sizeable stakes issued disappointing announcements. Within the span of a few weeks, first Tesco and then International Business Machines Corp. (IBM) and Coca-Cola Company all saw their share prices hit by weaker-than-expected earnings and other concerning revelations.

The share price of Tesco plc, the largest supermarket chain in the UK, dropped by more than 40 per cent this year in response to a series of unexpected announcements, namely, two separate profit warnings, change in management and, the most concerning of all, an overstatement in earnings forecasts by £250 million in mid-September. The company then issued its interim results in mid-October and, two weeks later, it was revealed that Berkshire Hathaway reduced its stake in Tesco to less than three per cent of the company from their previous holding of 3.97 per cent.

IBM and Coca-Cola rank among the three largest investments of Berkshire Hathaway. Warren Buffett’s company saw its value in IBM drop by nearly $1 billion in October after the company posted disappointing earnings. That same week, Coca-Cola also announced third-quarter revenue that fell short of expectations and warned of currency headwinds.

Coca-Cola had the largest negative impact on the value of Berkshire’s portfolio as the share price of the world’s largest soft-drink maker fell six per cent after an unexpected drop in third-quarter sales. Coca-Cola is struggling with slower international growth and mounting concerns over obesity and artificial sweeteners in the US. The drop in Coke’s share price reduced the value of Berkshire’s 9.1 per cent stake in Coke by over $1.04 billion.

Warren Buffett often advocates a strategy of a ‘buy and hold forever’. In fact, one of his famous phrases is “only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”. While this may have been successful for many of the companies he invested in over the years, the same cannot be said for the investment in Tesco. Berkshire started buying shares in Tesco in 2006 and built up a stake of almost five per cent in the company.

In 2007, Warren Buffett again opined on acquiring businesses that operate in markets that are relatively safe from new competitors.

One of Warren Buffett’s famous phrases is ‘only buy something that you’d be perfectly happy to hold if the market shut down for 10 years’

His explained this by comparing such companies to “strong castles with big moats” and in one of his famous annual letters to Berkshire shareholders, he wrote “a truly great business must have an enduring moat that protects excellent returns on invested capital”. However, this cannot be the case for Tesco as it has lost its ‘moat’ due to the intense competition from Aldi and Lidl. Last month, Warren Buffett departed from his conventional belief and reduced Berkshire’s stake in Tesco, incurring a sizeable loss in the process after calling this investment “a huge mistake”.

Although a long-term perspective is necessary when investing in equity markets and investors should, at times, ignore the fluctuations in the stock market (Warren Buffet claims that no one can accurately predict the direction of markets), the recent example of Tesco clearly shows that investors cannot be passive and need to follow company developments closely due to changing business dynamics.

Taking an active investment approach

Shopping trolleys at a Tesco Express in southwest London. Photo: Luke acGregor/Reuters

Another point to remember from last month’s events at Berkshire Hathaway is that investors sometimes need to take losses and move on. Although Warren Buffet states “be fearful when others are greedy and be greedy only when others are fearful”, his sale of Tesco shares after these fell by more than 40 per cent this year alone, is clearly contradictory to this statement and shows that even this legendary investor in certain circumstances may need to crystallise a loss and consider other propositions. In fact, some commentators have criticised Warren Buffett’s decision to sell Tesco last month and branded this as a “second mistake” since most of the bad news seems to be priced into the equity as it trades at a cheap multiple of only 5.4 times earnings. However, the decision to sell the shares is indicative that Berkshire believes that Tesco’s business dynamics have changed since it started investing in the company in 2006.

Likewise, other companies, both locally and internationally, also pass through such changes and investors need to revisit their investment portfolio exposures regularly to verify whether all companies have continued to perform positively or whether their industry landscape has changed. As an example, the regulatory changes within the European banking industry have started to negatively impact the financial performance of some local and European banks and the dividends they distribute to shareholders.

There are risks and opportunities in all equity investments

I continue to believe in the value-investing approach, that is, buying for the long-term and ignoring short-term volatility which generally arises from emotional behavior. We have undoubtedly had many attractive opportunities over the years, both locally and internationally, to take advantage of general investor panic and acquire shares at well below their fair value. Many investors also generally base their investment decisions on past financial performance while the future is what is more important. This could create market imperfections which other value investors can take advantage of. In the final analysis, however, investors must understand that there are risks and opportunities in all equity investments and sometimes it may take time for the share price of a company to reflect reality. This is where an active investment approach pays off as investment advisors can assist investors to take advantage of such market imperfections.

Investors therefore need to hold periodic meetings with their independent financial advisor who should be in a position to provide them with a detailed update on developments within a specific company and also guide them on their optimal asset allocation given their profile and objectives.

However, in order to enable financial advisers to explain company developments to their clients, publicly traded companies need to do their utmost to issue detailed and regular announcements and organise company briefings at least on an annual basis.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd (RFC) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

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Edward Rizzo is a director at Rizzo, Farrugia & Co (Stockbrokers) Ltd.