Warren Buffett says to avoid these two types of hot investments
This past weekend saw conglomerate Berkshire Hathaway hold its highly anticipated annual shareholder meeting, with tens of thousands of investors attending the event in Omaha, Nebraska. Participants flock to the meeting each year to listen to the company’s Chairman and CEO Warren Buffett and Vice Chairman Charlie Munger dispense their views on the company, the stock market and life.
This year was no different with Buffett (also known as the Oracle of Omaha) and Munger detailing some of their mistakes, as well as some of the investments that investors should be extremely wary of.
Here are two major investments that should be approached with extreme caution, according to Buffett.
1. The next hot IPO: Uber
Days after the annual meeting, CNBC asked Buffett if he was purchasing Uber, a ride-sharing company and one of the year’s most anticipated initial public offerings (IPOs). While Buffett didn’t address the merits of investing in Uber itself, he’s no fan of buying IPOs, because of the skewed incentives for Wall Street to peddle IPO stock regardless of its quality.
“In 54 years, I don’t think Berkshire has ever bought a new issue,” Buffett told CNBC. “The idea of saying the best place in the world I could put my money is something where all the selling incentives are there, commissions are higher, the animal spirits are rising, that that’s going to (be) better than 1,000 other things I could buy where there is no similar enthusiasm … just doesn’t make any sense.”
That’s an important warning for investors who are considering investing in IPOs. While some IPOs have done well, the incentive system is set up for Wall Street banks to generate a lot of excitement so that they can sell the new stock to the public. The recent poor debut of Lyft, which held a number of surprises for investors, should also be a warning in this regard.
Instead, Buffett suggests looking at the wide range of other stocks already available on the market that aren’t necessarily being hyped by the Wall Street money machine.
Finally, while it’s true that Buffett considered investing billions in Uber last year, he was considering a more complex deal than what would be available to individual investors. Buffett had proposed a deal that protected his investment if the company faltered, while giving him a potential gain if the company did well in the future.
It’s the kind of “heads I win, tails I don’t lose much” deal that Buffett has long been famous for. For Buffett, Uber was a risky enough bet that he wanted a lot of protection should it decline.
Still, Lyft’s poor debut does not bode well for Uber’s IPO, and both companies are losing extraordinary amounts of cash.
[READ: How to buy IPO stock]
2. Cryptocurrency is ‘probably rat poison squared’
Buffett has previously called the well-known cryptocurrency bitcoin “probably rat poison squared,” while Munger has likened trading in digital currencies to “just dementia.” Buffett’s comments this year were no less forgiving.
“It’s a gambling device … there’s been a lot of frauds connected with it,” according to Buffett. “There’s been disappearances, so there’s a lot lost on it. Bitcoin hasn’t produced anything. It doesn’t do anything. It just sits there. It’s like a seashell or something, and that is not an investment to me.”
For Buffett and other investors, as opposed to speculators, an asset is only an investment if it produces cash flow or has the potential to do so. For example, a profitable business is an investment, but items such as collectibles, gold or currencies can never be an investment.
A business may expand and grow its profits, leading investors to push the stock higher. In contrast, a collectible does not generate cash flow, so the only reason for its price to increase is because someone wants to pay more for it. This speculative approach is called “the greater fool theory” because it relies on someone willing to pay more for the item than you did.
Of course, Buffett also pointed out that cryptocurrency is not safe from theft, either, with much currency having been stolen or otherwise associated with fraudulent activity.
The big lesson from Buffett: Buy true investments, businesses that generate cash and have the potential to grow that cash flow over time — then hold tight.
[READ: Should you buy bitcoin?]
The one stock that got away
At the annual meeting, Buffett and Munger are often surprisingly candid about their mistakes, which are more typically errors of omission than commission. The pair takes a “value-based” approach to investing, trying to find a company that’s cheaper than it ought to be or one where the price does not reflect the ability of the company to grow its profits in the future.
One they let get away, however: Alphabet, the parent of Google.
“We screwed up,” Munger said. While the pair saw how much money insurance company Geico – which is owned by Berkshire Hathaway – was paying to Google to run ads, they didn’t invest in the search engine giant. Alphabet has been a long-term winner on the stock market.
And while Berkshire missed Alphabet and had avoided Amazon for many years, the company’s money managers have recently taken a stake in the e-commerce behemoth, according to Buffett. That’s certainly a vote of confidence for investors in Amazon stock.
If there’s a consistent theme to Buffett and Munger’s thinking, it’s this: Do a few smart things and avoid all the dumb things. In that respect, the latest Berkshire meeting in Omaha was no different from the many that came before it.
Meanwhile, investors would do well to heed the investing lessons that Buffett and Munger dispense for free:
- Be careful around IPOs – there’s probably a better deal on the market already.
- Avoid cryptocurrency.
- Stick to value investments.
Investors could do a lot worse than following Berkshire into some of its investments, even if all of them aren’t home runs. Since taking over Berkshire Hathaway, Buffett has led the stock to greater than 20 percent average annual gains over the past 50 years or so.