Why Buffett is smarter than you

By The Motley Fool

At 77, Warren Buffett is no spring chicken. The fact is, most people his age are looking to get money out of the market rather than put money into it.

Yet Buffett is continuing his life's work in the same way he always has.

See, in helping privately held Mars buy Wm. Wrigley Jr. (WWY, news, msgs) a couple of months back, the billionaire investor and chairman and chief executive of Berkshire Hathaway (BRK.A, news, msgs) made a deal with zero liquidity in sight. That's precisely the opposite of what you'd expect from virtually all investors in private companies (particularly venture capitalists), who demand a clear path to liquidity from the start.

The Oracle of Omaha has long preached that the long term is the only view for an investment -- even if the investor is beyond retirement age. He's said before that his ideal holding period is "forever" -- and the Mars-Wrigley-Berkshire deal is yet another example of Buffett putting that theory into practice.

Yet most investors have not learned this lesson. The average holding period for a stock is less than one year, according to recent data from the New York Stock Exchange.

Buffett's patience, discipline and willingness to act when others won't make him a better investor than you are.

Those aren't his only advantages, though. Not long ago, we wrote an article highlighting the reasons Buffett is a superior investor. It seemed like a truism to us -- the man has built one of history's great fortunes on the power of his investing acumen, after all. But some readers took offense.

We got e-mails telling us that Buffett has tons of advantages over the common man, ranging from his enormous cash war chest to his access to executives and other privileged sources of information.

While it’s true that few other investors could have contributed $3 billion to Dow Chemical's (DOW, news, msgs) recent buyout of Rohm and Haas (ROH, news, msgs), having lots of cash isn't necessarily the advantage many readers made it out to be.

Buffett's enormous cash position is actually a huge disadvantage when it comes to earning exceptional stock-market returns. It essentially prevents him from investing in anything other than liquid large caps.

Just glance at Berkshire Hathaway's Form 13F filing, and while you'd also recently find tiny liquidation play Comdisco Holdings, you'll predominantly find multibillion-dollar companies such as Bank of America (BAC, news, msgs), Home Depot (HD, news, msgs), NRG Energy (NRG, news, msgs) and SunTrust Banks (STI, news, msgs).

While those are solid companies, their size illustrates how small a pond Buffett generally fishes in (Comdisco is a shocking exception). According to Capital IQ, while there are more than 25,000 companies trading on the world's stock exchanges, there are just 2,130 capitalized at $3 billion or greater. That means Buffett's cash position effectively locks him out of 91% of public companies.

Further, because Buffett has said he won't invest in technology stocks, he's out another 585 opportunities, including companies he reveres, such as Google (GOOG, news, msgs).

All in all, Buffett is restricted to a universe of some 1,545 stocks -- which is far from ideal. In fact, Buffett has said that he could earn 50% annual returns each and every year if he if he had just $1 million to invest, because it would give him free rein in the market.

With just $1 million or less, Buffett could have taken advantage of recent ridiculously cheap opportunities in the micro-cap sector, such as when $19 million SmartPros (SPRO, news, msgs)traded at an absurd 1.7 enterprise-value-to-free-cash-flow ratio.

But because SmartPros is so small, Buffett never bothered with it. Heck, because SmartPros is so small, you probably didn't bother with it.

The exact same information

As for an informational advantage, yes, Buffett has connections. But when he bought a big stake in PetroChina (PTR, news, msgs), he admitted the only research he'd done was to read its annual reports. In other words, he acted on the exact same information available to all of us, and the producer of two-thirds of China’s oil and gas tripled during the time Berkshire owned it.

This brings us full circle. It isn't anything artificial that makes Buffett a better investor than you; it's his patience, discipline and willingness to act when others won't.

Buffett's abilities did not develop overnight. It's been a lifelong process -- one that he began at age 11. So while he may be a better investor than we are today, we can at least learn from his experiences and -- like he did -- become superior investors over time. That means:

• Buying for life (or, at least, the long term).
• Buying small (perhaps our lone advantage).
• Buying based on thorough research and due diligence.

This article was reported and written by Tim Hanson and Brian Richards for The Motley Fool. Hanson owns shares of Berkshire Hathaway. Richards owns shares of SunTrust.