If you are an investor and you want to optimize your stock market returns, it isn’t enough just to pick the right stocks - you must also know how to combine different stocks into a portfolio to maximize potential upside and minimize potential downside. You want to diversify – meaning reducing your risk, but you don’t want to diworsify – meaning reducing your investment returns. Luckily, Warren Buffett has got us covered on this topic, but he thinks that most investors tend to get this one wrong, so listen up.
Timestamps of Warren Buffett’s advice on diversification:
00:54 Warren Buffett’s Portfolio – Then and Now
04:47 Are You a Know-Something Investor?
06:57 Are You Investing in Risky Assets?
08:23 Are Some Opportunities Much Better Than Others?
09:24 Can You Earn It Back?
10:53 Applying This to My Own Portfolio
Here follows a few of the assumptions I used to compute Buffett’s current portfolio. Please note that these are simplified assumptions, appropriate for creating a pie chart in a video discussing diversification (I think), but I wouldn’t base any investment decisions on this. With that said:
1. Apple – Value: $135.2b (market value according to CNBC)
2. BNSF – Value: $128.8b (assuming same P/E as competitor Union Pacific)
3. BH Reinsurance – Value: $85b ((3y average earnings + 7% returns on float) x P/E 17)
4. BH Energy – Value: $71.3b (assuming same P/E as Consolidated Edison)
5. GEICO – Value: 69.7 ((3y average earnings + 7% returns on float) x P/E 17)
6. Bank of America – Value: $49.4b (market value according to CNBC)
7. BH Primary Insurance – Value: $28.9b ((3y average earnings + 7% returns on float) x P/E 17)
8. American Express – Value: $26.4b (market value according to CNBC)
9. Coca-Cola – Value: $22.5b (market value according to CNBC)
10. PCC – Value: $20b (purchased in 2016 for $32b and Buffett recently made a write-down on that purchase of $11b, so I think $20b is close to a fair value)
11. Cash & Equivalents (Parent Company Level) – Value: $12.3b
12. US T-Bills (Parent Company Level) – Value: $29.8b
13. Other Listed Securities (40+) – Value: $94.8b (market value according to CNBC)
14. Other Operating Companies (40+) – Value: $133.3b (the rest have combined pre-tax earnings of something like $10b, and I put a P/E 13 on that)
I looked at a bunch of insurance companies, like Progressive, Allstate, Hannover, Swiss Re etc, and although earnings can vary a ton from year to year for these companies, P/E 17 seemed to be the current market valuation for averaged yearly earnings. I notice no obvious difference in valuations between reinsurance and casualty insurance.
Also note that this will not add up to Berkshire’s current market cap of $650b, and that’s partly because Berkshire is leveraged, partly because the market may not agree with me on these assumptions.
My goal with this channel is to help you make more money and improve your personal finances. How to become a millionaire? There are many ways to get there – investing in the stock market, becoming a stock trader, doing real estate investing, or why not becoming an entrepreneur? But whether you are interested in how to invest in stocks or investing strategies for creating passive income with rental properties – I hope to be able to provide you with a solution (or at least an idea) here. Warren Buffett - the greatest investor of our time - says that you should fill your mind with competing ideas and then see what makes sense to you. This channel is about filling your mind with those ideas. And in the process – upgrading your money-making toolbox.