Buffett's "Dirty" Little Secret

Warren Buffett is always a hot topic and today I've asked Greg Roy, who has a unique opinion on Buffet's strategies, to share what he calls "Buffett's dirty little secret". Whether you agree or disagree,  Greg will certainly leave you with something to think about. Whatever your stance, we encourage you to comment below and dig deeper into Greg's reasoning with his latest report.


They’re missing the point.

Nine out of ten “gurus” who tell you to “invest like Buffett” preach that you should “buy great companies at a discount.”

And yes, on the face, that’s “what Buffett does” – but completely overlooks the real secret to Buffett’s investing genius.

I’ll be the first to admit I’m no “Buffophile” – some of the blind adoration heaped on him in some quarters I find not only distasteful but propagates dangerous attitudes about investing and trading. But I do think he’s as close to a genius as any investor in recent history.

Because Buffett is playing a completely different game than everyone else.

* There’s a reason none of the fund managers who try to mimic his investing style can match him – no “value” fund really can do what he does…

* There’s a reason none of the “investing gurus” who try to model his strategies can match his returns …

* There’s a reason why no one has come up with a trading strategy that consistently performs as well as Buffett across all economic and market environments …

And it has nothing to do with how great of a “stock-picker” he is.  I recently wrote a report detailing Buffett’s “Dirty” Little Secret explaining why he talks “buy & hold” but that has nothing to do with stocks. And why investors who got suckered into it have gotten their butts handed to them over the last few decades.

The fact of the matter is: Buffett has built his success on a frame-work of “free money” – even though he tells people never to invest with other people’s money that’s exactly what he’s done since the beginning.

From his first partnership where the majority of his money came from investing his partner’s money to the unique “float-centric” business model of Berkshire-Hathaway where he gets to buy companies using insurance premium money.

Buffett’s innovation is a business model where cash is his competitive advantage. He’s so successful because he does what I call “hyper-compounding” – he uses money to get more “free money” which he then invests into more cash-producing assets.

If you read his last shareholder letter you know he explained, “The engine behind Berkshire’s growth …allows us to enjoy the use of free money – and, better yet, get paid for holding it.”

He makes money six ways from Sunday on every investment.

For instance; did you know Buffett risked more money on an options trade than he laid out for Burlington Northern railroad – his biggest purchase ever? It’s true – he risked $37 billion because of the “free money” side of the equation which gave him close to $5 billion in free money to play with.

But investors keep getting fooled by all of the talk – they don’t see that “buy & hold” is Buffett’s ace in the hole in the favorite poker game of Wall Street Whales – it’s not an investing strategy for you and me. I explain why in this report: Buffett’s “Dirty” Little Secret

Warren Buffett’s spectacular track record is the elephant in the room for investors and traders. Love him or hate him, everyone seems to feel the need to understand his success -$10,000 invested in 1965 would now be $80 million.

But in that process I advise you to think for yourself.

Look at the facts and see if you agree with me it’s smarter to do as Buffett does, not as he says. Obviously, not all, or even most, of Buffett’s “free money” strategies are open to us – unless you buy an insurance company outright – but a few of them are.

And I for one think that’s worth understanding.

Greg Roy
Please grab my free report on Buffett HERE

26 thoughts on “Buffett's "Dirty" Little Secret

  1. Do we have access to those excel sheets in the report so we follow the logic?


  2. One thing I question in the intro to the article is that WB "gets" to use cash from the Insurance holdings of Berkshire. I would say he EARNED that privilege. It was not something he "got" like some kind of inside track not open to anyone else.

    There are tens of thousands of insurance co's and LP's in the world (Bernie Madoff, anyone??), yet only Buffet's generated Buffet-like returns. Ask yourself, "Why is he different?" Obviously there is investment acumen there that goes far beyond his access to "free cash".

  3. yes,

    but what do you have to say...about his bear market strategy...

    He got 3 decades of bull run...no doubt...

    Yet...Can you explain...step wise...how to use free money generated by dividends to buy another asset..

    That he is smart and shrewd in investing is common knowledge though...

  4. When Apple was under $100 he said he was buying ... please explain how buying it then and holding does not work for the average investor!

  5. Good article, but you forgot one other thing, he is the ultimate insider, go back and look at some of his purchases and see how the stock took a big dive just before he bought. The man is not only good he's lucky too.

  6. Well, ask yourself this, what have i done to act like buffet myself? I'm really happy to see this thread of comments a great argument both ways, I for one will be looking into using "Free Money" myself. Thank you INO for yet another great post.

  7. I am a huge Buffet fan...and I have done very well with both technical trading AND Buffet-like "buy-and-hold." One aspect of his investing I have had a hard time defending,however, was his agreement with government bailouts when so much of his net worth stood to benefit from these very same bailouts. I told one very astute commentator that Buffet's share of direct bailout money amounted to (only?) $7 billion and had these companies gone under, he would have survived, but the commentator said I was only counting equity...he said all told, buffet would have been decimated without bailout money.

    Any factual analysis out there of his comments?

    1. Agree re defending government bailouts that decimated the private sector for decades to come. Also advocating higher taxes when he dodged taxes with Foundations and buying tax credits...

  8. Lots of respect with no criticism of WEB here.
    Learned a lot from his Shareholder Annuals and Letters,
    archived on the BRK website.
    WEB admits his mistakes and concerns in a gentle way.
    He is not infallible. We can learn from his mistakes.
    WEB bought COP with oil peaking. COP bot Lukoil then wrote LUKOY off.
    WEB sold COP and wrote down his investment in Irish Banks.
    He did not say if his silver was optioned and called away from him by
    Barclays for their SLV. He did say he left a lot of money in
    the market. His Bridge Foundation buddy WHG III still owned
    PAAS last we knew with better than a triple at one point.
    WEB bought Kraft and thought they diluted their stock chasing Cadbury.
    He also noted his purchase of BNI and Mid-American marked the first time he did not buy a cash cow, but companies requiring capital to grow.On the other hand, rail may be the cheapest form of transportation, going a hundred miles on a gallon of diesel per ton, vs 10 miles for trucks.
    As mentioned by others, writing covered calls limits upside and only
    protects the downside a little bit. Writing option spreads generates commissions and money for market makers. Writing covered puts reduces
    cost basis a little, while writing naked puts because they are presumed overvalued at the time could not only generate more volatile earnings, because BRK, unlike big banks, marks its portfolio to market. Writing naked puts for decades could turn out to be up to a $37 B mistake less return on the $5 B premium if the market goes to new lows. If WEB lives long enough, he may see how it turns out. Meanwhile, he bet a million dollars on passive index funds for a decade over actively managed money...

  9. Lots of respect with no criticism of WEB here.
    Learned a lot from his Letters which are archived on the BRK website.
    WEB admits his mistakes and concerns. He is not infallible.
    We can learn from his mistakes.
    WEB bought COP which bot Lukoil then wrote LUKOY off.
    WEB sold COP and wrote down his investment in Irish Banks.
    He did not say if his silver was optioned and called away from him by
    BarclayS for their SLV. He did say he left a lot of money in
    the market. His Bridge Foundation buddy WHG III still owned
    PAAS last we knew.
    As mentioned by others, writing covered calls limits upside and only
    protects the downside by a little bit. Writing covered puts

  10. The average person can't even phathom how much Buffet is worth. When you have that kind of money, you can take enormous risk..which is what it takes to make it big in the markets. The average Joe can't afford to make risky bets. It's ridiculous to eveen try to mimic Buffet. If he lost everything, he would still have more money than the average person will make in a lifetime.

  11. Buffett started business as a kid. He had the bug for collecting. His stated strategy from very early on was to engineer free money, and to employ it in long term under value investments. He put minimal amounts of his own funds into most of his partnerships, and his aim was that by a policy of low or no distributions, he would build his equity up at an enormous compound rate in each vehicle. He was an outstanding success, both at sticking religously to his plan, and at choosing outstanding investments. Few people could do what he did; (1) because it took a lifetime of total dedication to the work,and having a wife and family that gave him total support; (2) because he stuck to his plan through thick and thin, against all criticism, which few can do, and (3) he mostly chose excellent investment vehicles. It is most unlikely that anyone as gifted and dedicated in this field will be seen again. Buffett is an oustanding success by any guage. It is worthless to criticize a life of this calibre, or to belittle in any way his achievement. You would think that people could just admire his success, and not feel the need to criticize it, wouldn't you? I wish I could build assets like him!

  12. A much better way to use the buy/write concept Roy is selling here would be to buy an in-the-money call option 6-9 months out and sell a slightly out-of-the-money call option 30-45 days out. Obviously, the higher the volatility on the stock the more you're going to make, but the same holds true for covered call concept, and using the ITM and OTM calls you can easily make over twice as much as with covered calls.

    This obviously works better in a bull market. And one important point. Roy is putting all his eggs in one basket (in the video with his Mother's account). Using the option strategy above you can pick 10 different stocks and put $5,000 into each one and spread the risk around. Way too much risk using only one stock, IMO.

  13. Nobody seems to get the point. The difference is the scale of capital and access to the market. If you don't have the scale of capital 45 billion dollars as in W. B. 's case, you will never be able to sustain one minute of volatility. Even if you have the capital you may not have the access to the market. Who do you think is the counter party to W.B.
    They are not buying that type option from anybody other than W.B. He is primarily an underwriter of the option, the market maker of option. Just like I say to you, if the world is coming to an end tomorrow, I will pay you a billion dollar, and if not you will pay me a million, would you do that bet.
    Let's be clear, if the world come to an end I will have no use for all the money I have, that is why I can bet I have.

    Got the point?

  14. Using derivatives with any portfolio is good sense providing you know how to use them. Free money for the avg trader is risky and is it really free if there is a risk. There is always a potential price to pay for Free money.

  15. Hei,

    Its better for us to aern money business and marketing and other stock trading iam enjoying now and further stating to you best guide to me.

    Raza Khan

  16. No Buffett does not buy and write.
    And no, he did not buy S&P calls.
    He sold naked puts on various global indices with no collateral,
    a far more dangerous game, after warning derivatives are weapons
    of mass financial destruction.
    Recall he plays Bridge, knows the odds and said if you don't know the patsy in poker in 45 minute, you're the patsy.
    As Mr Roy points out, Mr Buffett plays the float.
    He also is followed and imitated by many, meaning the only way
    to replicate his performance may be to join him with dollar-cost
    averaging BRK to beat him. He warned BRK performance may converge on
    the S&P, thus lowering expectations.
    The risk of playing the float is if naked options or insurance
    claims are called exceeding the premiums and their return.
    Perhaps that is why the credit agencies lowered BRK AAA credit,
    which he said did not make a difference on their recent bond float.
    Perhaps a long-term bluff if markets decline...

  17. Good observations and noteworthy as well as they support the old adage that "it takes money to make money". This point alone really illustrates how financial institutions are able to generate tremendous profits as the FED throws countless billions in FREE money in their direction! To add insult to injury, the administration and Congress allow these same institutions to manipulate the very markets that they are trading in. Investors should be outraged but no one seems to care.

  18. Looks like this strategy is about selling covered calls. Good idea if the market drops steadily for 5 years, but not so if the market goes up and the options are exercised. Much depends on option prices vs the price of the underlying stock i.e. market volatility. Buffett sold puts after a once-in-a lifetime crash - a no-brainer when you have access to the 20 year options market. The regular investor doesn't have access to options longer than a couple of years though.

    1. Actually its the exact reverse of what you said Lesley...rookies believe that if the stock gets called away that this is a negative result. I'll take that return any day of the week. On the flipside, a market dropping for 5 years will kill a buy/write strategy which has unlimited downside risk.
      ...and anyone could have sold puts after the crash and made money. I know I did, and you don't need "20 year" options to do it.
      My 2 cents...

  19. Mgv11, Buffett’s a genius. I’m not trying to take anything away from him.

    I’m not saying anything to invalidate Buffett’s approach of buying great companies at a discount. However, I do believe Buffett’s approach to buy & hold is fundamentally different than it’s generally perceived.

    If you track Buffett’s stock portfolio you see he trades more often and holds stock less often than so many of the ‘invest-like-Buffett’ gurus would have you believe.

    His approach is hands-down one of the most brilliant in investing history. But is it an investing strategy for you and me? Not necessarily.

    When Buffett buys a great PRIVATE company he is buying assets and cash-flow outright and then making the investment decisions for that cash-flow – often using float for the initial purchase – making it and all future purchases from the cash-flow essentially “free”.

    Even other companies like Markel, which some like to tout as a mini-Berkshire because of its insurance holdings, can’t keep up with Buffett’s operations just in terms of simply managing float. Because it’s important to note that Berkshire’s insurance operations like GEICO & GenRe are some of the tightest run in the industry in terms of managing their risk and float.

    Most other insurance companies can’t keep up. Let alone individual investors.

    The point on buy and hold is that it’s not as simple as buying a handful of great companies over the long term. And that’s especially true the closer you get to actually needing your money because if 3 out 4 stocks trend with the overall market you can’t afford to wait decades to make back losses.

    The shorter your time horizons, the more short & medium term losses hurt.
    The big points I take away from looking at Buffett’ track record is that his investing strategies are much more complicated than buying great companies at a discount.

    Buy & hold for him is one way he gets sweetheart deals you and I are not getting when buying stocks.

    His business model is genius because he’s essentially created a competitive advantage through cash – both because of billions in float and because he controls the cash flow of companies within the Berkshire conglomerate.

    The first thing he tells a new acquisition is to “fire your bank.”
    This cash advantage is another reason he gets discounts you and I could not get. He can basically set the deal – like he did with Goldman Sachs last year.

    Plus, he does plenty of shorter and medium term trading.

    For instance when you look at Buffett during the great inflation years of the 1970s you see his stock portfolio shifted largely into stocks with pricing power – including metal miners and advertising agencies. Stocks he sold out of after a relatively short period of time.
    Had he simply “held” them he’d have taken a bath. Instead, he generated something like 612% during those years, better even than gold returned during those inflationary times.

    Not to mention Buffett’s role in the public companies he’s bought has been anything but as a passive investor.

    From very early on in his career he’s gotten his hands dirty dealing with management and has no problem spending a year or two or three to get rid of and replace bad management.

    Is that something you’re in a position to do with the stocks you own?
    He even went so far with the Salomon Brothers deal to step in as interim Chairman and CEO – if he hadn’t that deal would have been a catastrophe.

    The mistake so many investors make is taking the idea of buying great companies at a discount and applying it unthinkingly to stocks.
    The problem isn’t with Buffett. It’s with not fully understanding what he’s doing.

    And MANISHA; I agree buy/write is not a great bear market strategy. Our approach is not limited to that. We’re happy to incorporate it when the opportunity arises but it doesn’t limit us by any means.
    We focus more on technical trading that allows us to make modest, short term gains with lower risk so that we can continually reinvest profits.

  20. Buffet is the largest derivative trader. He buys stock and collars them using dynamic hedging to increase his position size. That is how Bershire can increase in value as his buy and hold stocks barely move.

    He also buys 10 and 20 year call options on the SP500 as he alluded to in his letter to his shareholders during the middle of the GFC as the SP500 was plumeting.

  21. Your free money point is valid, but really in finance jargon this is opportunity cost, based on putting it in a very conservative investment. all you're asking him to do is subtract... the savings rate, I think that still puts him way ahead and still fullfills the buy great companies at a discount strategy, it doesn't invalidate it. Did I miss something?

  22. This probably works only in bull markets..only with strong and trending bullish stocks. That is the missing point...which stocks to do this on.
    Buy/ Write is worst in bear markets...losing in principle amount to make 2 - 4 % cash.
    There is more to it...WILL LIKE TO KNOW ABOUT IT?

  23. I am skeptical when there's no apparent downside to a proposed trading plan.

    MarketClub is concerned -- largely -- with using technical analysis to guide trading. But why be bothered with that if all that's required to make money endlessly and effortlessly is to buy stock and sell options?

Comments are closed.