Warren Buffett, you've let us down. Sure, you're a brilliant and sage investor, which is why a simple lunch with you still goes for $2.6 million -- which someone paid earlier this month in a charity auction.
But you've taken some fair criticism lately for your defense of Goldman Sachs (GS, news, msgs) and your investment in Moody's (MCO, news, msgs), tying you to the much-hated Wall Street bailouts. We've also seen that even you, the affable Oracle of Omaha, can make mistakes -- by, it seems to me, breaking your own rules.
Now, I'm not so presumptuous as to try to instruct Buffett. He's the sort of maestro one learns from. (In fact, one of my best-read columns ever for this website is "10 investing basics from Buffett.")
With that in mind, here are a few investing lessons for Buffett -- from his very own rule book, which he may have misplaced of late.
Lesson No. 1: Invest in what you know
A key Buffett rule: When you don't understand how a company makes money, avoid it. Buffett calls this "staying within your circle of confidence." This philosophy famously had him mostly in safer stocks such as Coca-Cola (KO, news, msgs) a decade ago when the tech bubble burst.So Buffett's recent statement that he knew little about what went on at Moody's during the housing bubble is a real shocker. Buffett's company, Berkshire Hathaway (BRK.B, news, msgs), is a major Moody's stockholder. Critics say Moody's was complicit in the mortgage meltdown because it gave high ratings to dubious subprime-backed debt, stoking the lending machine that fed the bubble.
When asked by the Financial Crisis Inquiry Commission this month whether he was satisfied with internal risk controls and oversight by Moody's management, Buffett said he didn't know much about how ratings on mortgage-backed securities were done. "I have never been to Moody's," he said. "I don't even know where they are located."
That seems like a basic violation of his rule to know what you own, and it theoretically cost him $120 million. That's how much Buffett would have saved if he had sold his current 30.7 million-share Moody's position near the peak for the stock, above $60 a share in 2007, because he didn't know what they were doing. Instead, he held as the housing bubble popped. The stock recently sold for $21.
Buffett told the commission he mainly liked the company's pricing power from being one of a handful of companies offering debt ratings, an advantage the company still has, points out Todd Lowenstein, a co-portfolio manager of the HighMark Value Momentum Fund (HMVMX).
Buffett also said it's common for him to own companies without knowing the details of how they operate. "We own a lot of Procter & Gamble (PG, news, msgs). . . . I don't know how they make Tide."
But with all due respect to the oracle, we all understand Tide. Rating high-risk mortgage-related debt instruments that even the experts didn't understand is a different thing.
Key takeaway: When you don't really understand what a company does, don't own it.
Continued: Be frugal, and buy frugal companies