Saturday, May 10, 2014

Cash management the Warren Buffett way

Hey guys, I know I haven’t updated my blog for quite some time. I had a lot on my plate lately. I also started watching the Big Bang Theory and got fucking hooked on it. So, yeah I couldn’t find the time to write articles. Anyway, enough of the small talk, let’s get down to business.  Have you ever thought about the percentage of your portfolio that should be allocated to cash? How about the part of your portfolio that should be allocated to cash-generating assets such as rental properties and dividend paying stocks?  I personally never followed any cash management guidelines. I just hold enough cash to not feel that I will have nothing but my dick in my hands if the market crashes. But it’s a fact that having good cash management skills which allow you to be greedy when everyone else is fearful can be the difference between superior investment returns and mediocre returns. And who better to learn cash management from than the O.G. of value investing, Warren Buffett.

We will try to get a picture of Buffett’s cash management principles by studying Berkshire Hathaway’s financial statements during the great financial crisis. At the end of 2007, just before shit started to get real, cash and cash equivalents made up 16.22% of Berkshire’s assets. Berkshire’s free cash flow as a percentage of average total assets was 1.89%, 3.86% and 3.56% for the year 2008, 2009 and 2010 respectively. You can think of free cash flow as similar to dividends, interest and rent generated by your portfolio.

It’s natural for cash-generating assets to throw off less cash during a recession. However, investors need to be reasonably sure that their portfolios can still spit out a decent amount of cash during tough times as that’s when their cash will work the hardest. For example, if I were to evaluate the income producing potential of a Blue Chip stock, I would look at how much earnings and dividends declined during the previous recession.

Some of you may be wondering if it’s too conservative to allocate 16% of your total portfolio to cash. Well, it depends on the situation. If Mr. Market is fucking giving away good quality business at 70 cents on the dollar, then it’s dumb to hold so much cash. But Buffett’s company had 16% of its assets in cash at a time when markets were overvalued. You can generally build up a significant amount of cash during a bull market when stocks are overvalued. Just don’t reinvest the income from your portfolio in overvalued shit. I truly believe that another key to superior returns is patience. You don’t see Buffett making investments just to keep busy. The man waits till the price is right before making big bets.

At the end of the day, you should only look to Buffett for guidelines on how to manage cash. How you manage your portfolio’s cash allocation and cash flows should be based upon your own independent judgment. Another little tip for newer investors out there: only invest money that you can afford to lose, never put yourself in a position to end up as a broke ass mofo. Thank you for reading. Take care and stay rational.

No comments:

Post a Comment