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Rupert Hargreaves
Rupert Hargreaves
Articles (855)  | Author's Website |

Warren Buffett on His 10% Rule

The guru explains why he does not like buying more than 10% of public companies

June 24, 2019 | About:

After several decades of trying to avoid the airline sector altogether, Warren Buffett (Trades, Portfolio) has changed his mind over the past several years and now really likes it. There's one airline he loves more than most, and that's Delta Air Lines Inc. (NYSE:DAL).

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Airline buying

Buffett likes Delta so much that he recently crossed the 10% threshold in the company's stock. At the beginning of the year, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) increased its stake in the airline to more than 10%, the level at which it has to start reporting movements in its position to the market daily.

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When he was asked why he decided to cross the 10% threshold during an interview with CNBC a few weeks later, Buffett responded:

"What I didn't realize was that that purchase had taken us over 10%. I was already in territory I didn't plan to get, so I just decided to buy a whole lot more stock."

The Oracle of Omaha said it was a mistake that he went over the self-imposed 10% barrier, but I think it's unlikely this was a genuine blunder.

Buffett is one of the greatest investors of all time and is well known for his skill with facts and figures. I think it's highly unlikely he didn't know where the 10% marker was. If it was a genuine mistake, it must be the first time in his career that Buffett has gotten the numbers wrong.

Going over 10%

Speculation aside, it's interesting to know the reasons why Buffett does not want to go over this 10% threshold when buying stocks. He was asked about this at the 2019 Berkshire Hathaway annual meeting of shareholders.

On some occasions, primarily with financial companies, Berkshire is not allowed to go over the 10% boundary due to restrictions put in place by the Federal Reserve, though the Fed is gearing up to relax these rules, potentially allowing investors to own up to 25% of a bank without triggering more restrictive rules and oversight.

But there's another critical reason why Buffett does not like to go over this boundary, as he explained at the meeting:

"Many people probably don't even...know about this, but if you own over 10% of a security...and you sell it within six months at a profit, you give the money over to the company, the short-swing profit that you give them and match...any sale against your lowest purchase...

So, it restricts significantly your ability to reverse a position of change your mind or something of that sort."

It is fascinating to see Buffett, who is one of the world's most vocal advocates of long-term investing, so worried about trading conditions over a six-month time frame. The concern could also have something to do with the fact that Buffett is Buffett, and any time he goes over the 10% boundary, thousands of other investors around the world will all follow him. That's something he's thought about as well:

"I think you have to report within to or three business days every purchase you make once you're over that 10% factor. So, you're advertising to the world, but the world tends to follow us some, so it really...it has a huge execution cost attached to it."

Time to buy more

After highlighting the three main rules that stop Berkshire from buying more than 10%, Charlie Munger (Trades, Portfolio) added, "but if we didn't have all these damn rules, we would cheerfully buy more, wouldn't we?"

To which Buffett replied, "Yeah. And you'll probably see us at more than 10% in more things. And if the Fed should change its rules, there will be companies where we drift up over 10% simply because they're repurchasing their shares. That's been the case with Wells, and it's been the case with an airline or two in the last year or so."

Buffett concluded by saying, "So, if we like 9.5% of a company, we'd like 15% better, and you may see us behave a little differently on that in the future."

Disclosure: The author owns shares of Berkshire Hathaway.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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