Motley Fool: Investing in Warren Buffett

Warren Buffett has built Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) into a behemoth: It has a diversified set of more than 60 subsidiaries, including insurance, energy, furniture and jewelry companies, along with the BNSF railroad, GEICO, Fruit of the Loom, Benjamin Moore and International Dairy Queen. It also holds a massive portfolio of stocks, including big stakes in companies such as American Express, Apple, Coca-Cola and Wells Fargo.

Even though Berkshire was recently valued at more than half a trillion dollars, Buffett thinks it’s cheap. The company bought back almost $1 billion of its own shares in August, and more buybacks could be coming. Buffett’s aversion to overpaying for companies is one reason Berkshire has thrived. As he says, “Be fearful when others are greedy, and greedy when others are fearful.”

Buffett has cautioned investors that Berkshire’s future returns won’t be nearly as strong as the roughly 21 percent annualized return it’s produced since he took the reins in 1964. And, at 88, Buffett won’t be in charge forever. But as long as his successors stick to his conservative, value-based approach, Berkshire can continue to thrive. (The Motley Fool owns shares of and has recommended Berkshire Hathaway.)

Ask the Fool

Q: If I own 1 percent of a company’s stock and the company earns $100 million, do I get 1 percent of that, or $1 million? – P.G., Hickory, North Carolina

A: Not quite. If you own stock in a public company, you do own part of it, but corporate earnings typically don’t get automatically sent to shareholders – at least not in full.

A company can do a bunch of things with its profits. It might, for example, pay down some debt, pay dividends to shareholders, buy back (and essentially retire) some of its own shares or reinvest in its business by building factories, hiring more workers, buying advertising and so on. It might do a combination of those things, and may just bank the money, too, waiting for opportunities.

All these options can reward shareholders, sometimes even more powerfully than if the money were just distributed as dividends. Shareholders are also rewarded when the company grows and its stock value rises accordingly.

Q: Can you explain “unrealized gains”? – W.F., Warsaw, Indiana

A: When you sell an investment, you’ll usually realize a gain or loss. For example, if you bought shares of Scruffy’s Chicken Shack (ticker: BUKBUK) at $50 each and then sold them three years later at $62, you’ll have a realized gain of $12 per share (less commission costs).

Meanwhile, imagine that you bought shares of Home Surgery Kits (ticker: OUCHH) at $22 apiece and they’re now at $27. If you haven’t sold any shares, you’ve got an unrealized gain (or “paper profit”) of $5 per share. Since you haven’t actually sold the holding, it’s your profit in theory only and an unrealized gain. It will be realized when you sell.

My dumbest investment

Years ago, when I started investing in individual stocks, I ran across a stock tip online. I saw the company had been trading at low levels, but in the last hour, it was climbing. I jumped in, thinking I could watch it and time my exit well. In less than 15 minutes, though, the company plunged from about 12 cents per share to less than a penny per share. I lost almost all of my investment. I’m convinced the recommendation was designed just for this purpose, to push up the price of a worthless stock. I feel like I ended up just giving my money to a thief.

Afterward, on discussion boards and through articles at The Motley Fool and elsewhere, I learned to make much better investing decisions. If I need a “timing” fix, I play in bitcoin. – C.H., online

The Fool responds: Your suspicions were likely right: You got burned in a classic penny stock “pump-and-dump” scheme. Beware of any stock trading for less than about $5 per share, as those are often penny stocks that can be easily manipulated.

Understand that timing the market is a dangerous game, as no one can really know exactly when a stock or the overall market has hit a peak or a bottom. Market timers often lose out. Be careful with bitcoin, too, as it has also burned a lot of investors.