Another Great Lesson From Warren Buffett

On Tuesday American billionaire investor Warren Buffett was probably busy welcoming US banking giant Goldman Sachs into the Berkshire Hathaway (a US-based conglomerate controlled by Buffett) family.

Amazingly, Buffett has managed to grab a US$2.15b stake in Goldman Sachs for free. Zero dollars spent.

How did Buffett do it?

We have to wind the clock back to 2008 when the Great Financial Crisis was in full swing. Back then, Buffett came to the rescue of Goldman, which badly needed fresh injections of capital, with a US$5b purchase of preferred stock in the bank.

The preferred stock came with hefty 10% annual dividends and more importantly, also came with warrants that gave Buffett the right, till 1 Oct 2013, to buy 43.5m common shares in Goldman at an exercise price of US$115 per share.

After Goldman repurchased Buffett’s preferred stock in 2011, the warrants were renegotiated by both parties and the terms of the deal were changed.

The new deal would give Buffett the option to receive common shares of Goldman that carries a value equal to the difference between the average closing price of Goldman’s shares in the 10 days prior to 1 Oct 2013 and the exercise price of US$115 per share, multiplied by 43.5m.

With the 10-day average closing price being US$164.38 for Goldman, the math thus works out as such: (US$164.38 – US$115) x 43.5m = US$2.15b.

And to make it clear, this US$2.15b stake in Goldman would be pure profit should Buffett choose to sell it right away. But of course, the Oracle of Omaha would likely not do so, given that he’s gone on record back in March to say that he “intend[s] to hold a significant investment in Goldman”.

While us private investors will very likely never ever get such fantastic deals like the preferred-stock-cum-warrants one that Buffett struck with Goldman back in 2008, or a favourable restructuring that Buffett managed to arrange with Goldman regarding the warrants, there’s still a very important lesson we could learn from the deal.

Back in 2008, when the financial world was creating a ruckus about doomsday arriving, Buffett wrote this as part of an op-ed he did for The New York Times (emphases mine):

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.

And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions.

But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

Based on his purchases for shares in Constellation Energy, Goldman Sachs, and General Electric among others during the financial crisis, he was indeed putting his money where his mouth is. And boy did he make out like a bandit, as exemplified by his experience with his investment in Goldman.

Buffett’s eventual successes in the investments he made in the Great Financial Crisis provide a blueprint for us to follow: seeing opportunity when others see fear.

We’ll never get superb deals like the one Buffett got but that doesn’t mean us individual investors can’t find good deals lying around.

In Singapore, the Straits Times Index (SGX: ^STI) was valued at around six times during the nadir of the financial crisis on 10 March 2009 giving it a great margin of safety. Investors who bought into the index through the index tracker SPDR STI ETF (SGX: ES3) would now be sitting on gains of close to 115% after four-and-a-half years. Isn’t that a great deal?

We also have shares like aircraft maintenance firm SIA Engineering (SGX: S59), marine engineering company Sembcorp Marine (SGX: S51), and Oversea-Chinese Banking Corporation (SGX: O39) that have gone on to deliver total returns (after accounting for dividends and stock splits) of 302%, 278% and 200% respectively in the same period.

Those are just three examples of many that have managed outsized-gains since the financial crisis.

Foolish Bottom Line

John Templeton, a phenomenally successful investor in his own right, once famously said that “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

That’s just a different way to word Buffett’s dictum of being fearful when others are greedy and being greedy when others are fearful.

I have no idea when the next big recession or stock market meltdown will come. But when it comes, trust me – it will be ugly and it will be painful. Pundits and doomsayers will come out in force saying the worst is yet to come and that the world’s ending.

But I won’t pay heed to them. Instead, I’ll think Foolishly and look at what investors like Buffett and Templeton have said and done and pick up shares with glee, despite that all too familiar of fear that would naturally well up when trying to invest in times of crisis.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing owns B-Class shares in Berkshire Hathaway.