How Buffett is getting richer

By The Motley Fool

It took him long enough.

At the end of 2004, Warren Buffett's Berkshire Hathaway (BRK.A, news, msgs) had about $44 billion in cash. Ditto for 2005. And 2006. And, yes, 2007 as well.

At one point, more than 20% of Berkshire's assets were earning money market returns.

• Top Stocks: Buffett is now more wealthy than Gates

While armchair investors complained that the company had amassed too much capital to continue its market-thrashing ways, Buffett simply sat on Berkshire's enormous pile of cash. And waited. And waited. And waited some more.

He refused to buy until the time was right.

The time is right

Buffett has called the current mess an "economic Pearl Harbor." The 78-year-old investor, businessman and philanthropist also said, "In my adult lifetime, I don't think I've ever seen people as fearful economically as they are now."

These aren't just words. Mr. Greedy When Others Are Fearful has been stuffing money where his mouth is.

That $44 billion that Berkshire had at the beginning of this year was down to $31 billion on June 30, as Buffett had made a slew of deals, including a $4.5 billion purchase of Marmon Holdings, the Pritzker family's collection of 125 companies; a $6.5 billion injection into Mars to help the candy company acquire gum maker Wm. Wrigley Jr.; and a pledge of $3 billion to Dow Chemical (DOW, news, msgs) to assist with its takeover of rival Rohm & Haas (ROH, news, msgs).

Buffett also bought up auction-rate securities at bargain prices.

In recent weeks, Buffett's pace of activity has accelerated. He's invested:

• $4.7 billion to acquire Constellation Energy (CEG, news, msgs) for $26.50 a share. (Shares of the electricity and natural gas distributor had traded above $107 in January.)
• $5 billion to buy perpetual preferred stock in Goldman Sachs (GS, news, msgs). The deal gives Buffett not only a hefty 10% dividend but also warrants allowing him to buy $5 billion of common stock at $115 per share.
• $3 billion in General Electric (GE, news, msgs) in a similar arrangement to the Goldman deal, except the preferred stock is callable for a 10% premium after three years. The warrants allow him to buy stock at $22.25 per share.

That's more than $20 billion spent in the past month, if he chooses to exercise those warrants. Buffett's back, baby!

Historically, average investors could simply ride Buffett's coattails to huge returns (think double the market's return). But this time is different.

Buffett got sweetheart deals on both Goldman and General Electric. In the case of GE, he's earning 10% dividends on a company rated AAA. If he buys the warrants and they pan out, he'll earn even more.

When Buffett made these deals, he was providing much more than just capital. He was lending his credibility, and that meant Goldman and GE were willing to give him great deals in the hope that his name alone would stabilize their stock prices for follow-on offerings.

In other words, don't buy into Goldman or GE just because Buffett has.

Take emotion out of the equation

Instead of buying what Buffett is buying, we should look to what his strategy has to teach us. So what can we learn from Buffett's shopping spree? Two things:

• Invest for a lifetime.
• Compile a watch list of attractive companies.

Buffett hasn't panicked during the recent financial turmoil, and he hasn't tried to make a quick buck. Rather, he's investing for the long term. In the past few years, that has meant waiting for opportunities to present themselves, and striking with a vengeance when they do.

And because of his patience, he hasn't had to compromise. He's getting great companies at great prices.

When Constellation Energy's price dropped so precipitously in mid-September (from above $60 to the $20s), he was ready to pounce. Goldman and GE may have approached him, but you can be darn sure he'd already done the bulk of his research beforehand.

To be great investors, we need to be similarly prepared. In volatile times, Mr. Market presents us with loads of great values. But just because a stock price has fallen doesn't mean the company is a good value.

A prudent way to take emotion out of the equation is by compiling a list of companies you'd love to own for the long term, and the prices you'd love to pay. When one of your favorite companies goes on sale, you can revisit your list, make sure your investing thesis is still intact and bend it like Buffett.

This article was reported and written by Anand Chokkavelu for The Motley Fool. At the time of publication, he owned none of the shares mentioned.