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Buffett Could Make 50% a Year, but Maybe Not With Deep Value

- By Rupert Hargreaves

In 1999, Warren Buffett ( Trades , Portfolio ) made a comment that has haunted him ever since.

In an interview with a local newspaper, the Oracle of Omaha declared he could make a return of 50% per annum if he were managing a much smaller sum of money.

When one shareholder asked him about this comment at the 1999 Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) annual meeting of shareholders, he responded by saying, "I may have been very slightly misquoted, but I certainly said something to that effect."

"I could name half a dozen people that I think can compound $1 million at 50% per year -- at least they'd have that return expectation -- if they needed it," he added. "But they couldn't compound $100 million or $1 billion at anything remotely like that rate."


Berkshire's chairman and CEO tried to hammer this point home in an interview with Bloomberg Business Week a few weeks later:

"If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."

He went on to say roughly the same thing in 2007, telling shareholders at the annual meeting that if the company's assets under management were much smaller, returns would be much higher. The guru also cautioned:

"We cannot earn phenomenal returns putting $3, $4 or $ 5 billion in a stock. It won't work - it's not even close. If Charlie and I had $500,000 or $2 million to invest, we'd find little things we could do, not all of it in stocks."

Jumping forward to 2019, the topic came up once again at the annual meeting. Citing Buffett's previous comments on the matter, a shareholder wanted to know what type of strategy he would use to try and generate these 50% per annum returns.

Buffett told his audience that the method he would use to produce market-beating returns "might well be the arbitrage strategy, but in a very different, perhaps, way than customary arbitrages, a lot of it."

"I can assure you if Charlie was working with a million, or I was working with a million, we would find a way to make that with essentially no risk, not using a lot of leverage or anything of the sort," he added.

He said the key to making these kinds of returns is to take advantage of "little fringe inefficiencies that people don't spot."

Unfortunately, as Buffett went on to add, these "little inefficiencies" don't have "any applicability to Berkshire" because the group is managing far too much money today.

There are two ways of looking at these comments. First, they're a warning from Buffett to shareholders of Berkshire not to expect 50%-plus per annum returns as those kinds of profits are just not possible for a company of its size.

Second, the comments appear to be advice on how investors can carve out their own niche and build a small fortune by concentrating on opportunities that the rest of the market is overlooking.

These don't have to be stocks, and investors shouldn't focus all of their efforts on the equity markets. It can be real estate, debt, private equity or farmland. Over the years, Buffett has made fantastic profits from all of these asset classes.

The key to these returns has been finding assets trading at highly discounted valuations and taking advantage of the market dislocation quickly. It would be a mistake to buy cheap stocks and hope they go on to outperform.

Producing returns of 50% or more per annum requires hard work, concentration and a broad range of assets to choose from. That's what Buffett seems to be suggesting anyway.

Disclosure: The author owns shares of Berkshire Hathaway.

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This article first appeared on GuruFocus.