Warren Buffett Pulled Off The Greatest Trade Ever

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed how Warren Buffett Pulled Off The Greatest Trade Ever. Here’s an excerpt from the episode:

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Warren Buffett Pulled Off The Greatest Trade Ever

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Tobias: Well, I’m going to be talking about something good. I tweeted this out on Friday. I truly believe it– I can’t believe he doesn’t get any credit for it. Warren Buffett has pulled off the greatest trade ever and nobody seems to have noticed. Such a funny thing. It’s something I’m going to be talking about right after this probably. [onomatopoeia] There’s the intro music. What do you want to do, fellas? Should we kick it off with the good stuff? Get off on a high note?

Jake: Yeah, Toby, you go first.

Tobias: I love that Greg Zuckerman book, The Greatest Trade Ever, where he talks about Paulson turning his fund into a multibillion-dollar fund. He’d been a risk arb, merger arb, making some money but not very well known. And he’s outside of Paolo Pellegrini. He comes in and says, “Have you noticed that if real estate prices just stop going up, then all of this housing crashes down.” So, he creates this fund, puts on this big trade. Probably, they stole it from Mike Burry. I don’t know. Mike Burry might have been the one who came up with it.

Paulson makes like $10 billion or something like that in the fund off a billion-dollar position, so 10x. But putting in a billion, and he could have dusted the lot. That gets an entire book written about you as The Greatest Trade Ever. And I’ve been seeing all these things about how much Apple not makes up in Buffett’s portfolio. So, it’s 20% of Berkshire Hathaway. It’s 40 something percent of his book.

Jake: It’s a 120% of book value, I think.

Tobias: [laughs] That would be very high-quality book value and Berkshire should be getting some credit for that. But basically, the last numbers that I checked, it was like a $36 billion investment, which is already a sizable chunk of the book. And it’s a $92 billion as of the close on Friday. So, he’s made $56 billion. He’s been in the position I know since 2016, but the position has grown considerably over that period of time.

I just think it’s crazy. It completely flies in the narrative that Buffett’s completely lost it. Buffett doesn’t like tech. He’s taken this gigantic concentrated position in a very well-known company, anybody could have done it, and had this massive return and got no credit for it. So, I just wanted to make sure he got some for it.

Jake: What have you done for me lately? [crosstalk]

Tobias: Yeah, I feel like that’s pretty recent.

Jake: Yeah. I think it’s a testament to how quickly we forget things and we ignore– it’s amazing that to do something of that size and have that result. That’s why it’s the greatest ever is because the size of it is just almost incomprehensible.

Tobias: I made the comment that he’s a Kelly-type investor. I’m not saying he’s gone and done a Kelly calculation. I got someone in my DMs telling me that I’m wrong that it’s not a Kelly position. I know it’s not a Kelly position. I’m referring to Bill T. Ziemba, who’s the Kelly guru along with Thorpe, who said that Buffett’s investment strategy follows a Kelly-type path. That means he takes big concentrated positions in the things that he agrees with and things that he likes. He’s done it again. So, it flies in the face.

There’s this some pretty famous response to Kelly theory written in one word, and I think it’s Samuelson’s– it’s just escaping me now who wrote it. It’s an entire paper written in one-syllable word, except for the final word which is syllable. And basically, says that the idea of Kelly, like maximizing your geometric return is not right. For example, you’ll take a lottery ticket bet even though you know that a lottery ticket– your expected return on a lottery ticket is you lose money on it because it’s not worth what you pay for it. But you would still do it because it costs you virtually nothing. And if it hits, your payoff is so big, it changes your life.

On the other end of the spectrum, if you win that lottery and then someone comes and says to you, “Well, I’ll flip you for it, you can double it or I’ll triple it, and if you lose, you give me everything.” You’re not going to take that bet either even though Kelly says you should because the downside is too great. It affects your life negatively. So, Kelly’s imperfect but for a very, very large number of situations in the middle, Kelly, properly sized down is a fine way of doing it.

And Buffett’s proven it. He’s very, very rich and he’s gone and taken a gigantic Kelly position. So, pay that old man. He’s done well.

Bill: Pay that man his money.

Tobias: Pay the man his money. Don’t splash the pot.

Bill: My buddy, who is a pretty successful dude likes to– he frames things through like step changes in your life. I think that that’s a pretty good way to apply, like a real-world Kelly bet, where he’s like, “I’m not going to risk this unless I can meaningfully change my quality of life.” If he feels like he can, he’ll bet. But it gets harder– He’s the one that lives on the beach in LA. The next bet he makes is almost like he’s got to get a jet. [crosstalk]

He’s not betting anything right now. And he thinks the entire world’s crazy. That’s through the framework of like, look at all the risks that you all are taking right now when there’s a huge business cycle risk. I’m sitting here cashed up on the beach, why would I risk what I currently have to walk into this? This is insane. It’s interesting. It’s definitely not a textbook method of investing. He made his money flipping oil companies. He was a general partner on the operating level within a fund. So, he bet everything he had twice and he had other people’s money to play with and he won. He’s a beast. Some of that’s resulting a lot of it’s because he’s actually very good at execution.

But his framework of how he bets is a very interesting thing that I think about a lot. I’m like, “Okay, is what I’m betting worth what I’m actually gaining in reality?” Forget about the numbers, is this bet worth making from a lifestyle standpoint? It’s helped me sort of pare down what I like to look at and what I don’t.

Tobias: I think that that’s a little bit– I think we were talking about that last week or the week before when we were talking about the farm. It’s apocryphal, but the farmer who doesn’t do anything for seven years and every now and again, when there’s a crash, he rolls into town, buys everything that he can buy and then goes back. And we were talking about in the context of Munger, who just does nothing for years and years and years. Finally gets his pricing Wells, which is a subject today and Bank of America, was that what he bought it in?

Bill: Yeah.

Tobias: Like, literally pulls over the 405 to phone in in the trade. That’s FOMO.

Bill: Trevor Scott, he’s at Tidefall Capital I think. He had a tweet today, that was funny. He was like, you think you’re having a bad year and he posted the Daily Journal portfolio and it’s 59% Bank of America and 48% Wells or something like that, or that’s too many percent. [crosstalk] Yeah, too many percent. But anyway, it was funny. It was a good tweet. Well done, Trevor Scott.

Jake: I like that framework that your friend has because it forces you into very asymmetric bets. You don’t take the 10% upside roll of the dice with a really long tail of potential outcomes that are bad. You wait until it’s like, well, this is either 10x or maybe zero, but it’s not going to be a small outcome.

Bill: Yeah.

Tobias: It’s a better framework than getting bored and doing something.

Bill: Yeah. I question how I’m implementing it sometimes because I look at my portfolio and it skews big and it’s like how the– large seems by definition to have more of a concave than a convex outcome set. Part of me is, why am I being a salmon swimming upstream? That doesn’t make a ton of sense to me but like Charter and TransDigm– we’ll see on Transdigm but Charter I bought when it was a unique operational hiccup and everybody puked it. Transdigm, I think it was somewhat similar, but it was macro. Wells, I’m finding harder, but we’ll talk about that soon. But that would be the only way that I would defend where I play and when I typically get into things.

Jake: Does that take out all of the big tech things then? We’re going to go from $2 trillion for Amazon to $20 trillion?

Bill: Yeah, I mean, it hasn’t historically– I’ve owned Google for a while. I currently on a little of Microsoft. I’ve been trimming that quite a bit. And I owned Amazon from November to recently. But yeah, I can’t hold it here. It’s not in me to hold something at that valuation.

Tobias: I always think the big round numbers are funny though. At some point in investing, we went through from millions to billions. Do you think people were saying, “Oh, well, now, we’re billions. This is too big,” without considering all of the underlying– Just ignore the– And I know that this is not stuff that I would buy, so it’s easy for me to say and not have to do it. But I do think about like, do you really care if it’s a trillion-dollar company, why can’t it become a $20 trillion company?

Bill: Yeah, I don’t know.

Jake: You can, but what’s a loaf of bread going to cost in that?

Tobias: Yeah, a lot. [laughs] $1 billion.

Bill: That said, man, you don’t want to sit on cash while that world happens. I mean, you’re not going to able to buy [crosstalk] cash.

Tobias: Well, that world is happening right now. That’s why where we are where we are.

Bill: Yeah. Tesla, I’m sorry, we’ve been wrong on it forever. I don’t know what it’s trading at today, call it $300 billion. That’s got to print money at some point if you think that you’re going to pay $300 billion, say that you want 7% on your equity, you still got to come up with $20 billion in cash flow at some point, even if you’re not going to discount it. It seems to me to be a lot of free cash flow for a company like that to print but maybe I’m wrong. I’ve been wrong before. I’ve been wrong on that particular name.

Tobias: I think it’s always hard to imagine the numbers getting as big as they do. A trillion-dollar company, even 10 years ago, would have just seen absolutely– $100 billion company seemed like a gigantic company 10 years ago. Now, a trillion-dollar company does five– [crosstalk]

Jake: Yeah, that’s just an IPO of a hydrogen trucking or some shit.

Tobias: Yeah, that’s right. You just have to have a PowerPoint presentation, your money good. PowerPoint presentation back into a SPAC, you’re done.

Bill: The thing about Amazon is AWS– I’m doing this on memory, but I do think you have a 28% return on assets growing at 30% with a long runway. I get why people think that that’s worth a lot. Even when I try, I can’t get myself north of $800 billion for that company, and that’s like being pretty generous.

Jake: That’s 50% haircut from here.

Bill: No, I’m saying AWS. I can maybe [crosstalk] $800 billion at some point. That’s not a bet I want to make, I can just make the argument. You know what I mean? I would not place my chips on that valuation.

Tobias: Dude, you did the Tesla right up at 5%, had to look at it?

Bill: [chuckles] That’s right. Yeah.

Jake: Yeah.

Tobias: It’s like, “Whoa, $100 trillion company.” [laughs]

Jake: There’s a variant perception.

Bill: Look, I’m not the smartest guy in that name. I bet Marcelo P. Lima has a lot of reasons that I’m wrong and he might be right. He obviously thinks about that stuff a lot more than I do. But I can only handle what I can handle. My brand is smaller than some. I try to stay in my spots.

Tobias: Yeah. You do better with whatever it is, 115 IQ, acting like you got 100 IQ than you do with a 130 IQ like you got a 150.

Bill: I guess, I don’t know. Sometimes, I wonder when I watch these tech stocks rip. I think maybe I need to go lower or higher. Stocks go up, buy them.

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The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”