Buffett's Investing Wisdom - Who's Swimming Naked?

You only find out who is swimming naked when the tide goes out. – Warren Buffett

Unwise business plans can often lead to huge profits… over the short term. When the economy is roaring and everything is moving up and to the right, it’s far easier for companies to hide dumb, corner-cutting, or even illegal practices as they rake in profits. Eventually though, the environment changes, those ill-advised practices are exposed, and the companies employing them -- and their shareholders -- get punished.

Thinking back to the dot-com boom, online grocer Webvan is a perfect example. After pricing its 1999 IPO at $15, the stock traded up to nearly $25 -- up 66%! -- on its first day of trading. So what if the company was losing money, it had a questionable business plan, the economy was booming, and internet stocks couldn’t lose!

As we know now, it couldn’t last. As the stock market boom turned to bust and the economy cooled, Webvan’s approach to online retailing -- which only led to mounting losses -- left investors cold. Unable to fund its massive cash bleed, Webvan declared bankruptcy in 2001.

Of course, we have a plethora of even more recent examples of businesses caught swimming naked thanks to the housing bust and financial-market meltdown in 2008. Chief among those examples is Lehman Brothers, which was an investment bank that was raking it in prior to the crash by employing large amounts of ultra-short-term loans to finance risky, complex real-estate investments. When the market turned, Lehman’s lack of swimming trunks was painfully obvious, and in 2008, Lehman filed the U.S.’s largest corporate bankruptcy.

Buffett’s “swimming naked” quote provides us with plenty of cautionary tales and gives us an idea of companies we might want to avoid investing in. If we flip it on its head, though, it also reveals companies that are great investing opportunities.

For example, let’s look at the credit crisis again. Lehman Brothers declared bankruptcy, Fannie Mae (OTC: FNMA) and Freddie Mac (OTC: FMCC) were put into government conservatorship, and Bear Stearns narrowly avoided bankruptcy by agreeing to be bought out by JPMorgan Chase (NYSE: JPM). But Wells Fargo (NYSE: WFC) and U.S. Bancorp (NYSE: USB) both made it through the crisis without reporting a single unprofitable quarter. Though they both accepted government bailout money, it’s unlikely that either truly needed it. In fact, Wells Fargo’s chief executive at the time argued vociferously against taking bailout money, but regulators overruled the request.

When the tide went out, we saw that both Wells Fargo and U.S. Bancorp not only had their swimming suits on, but were wearing suits of titanium. The washing out that came with the financial crisis revealed both banks as great companies to invest in for the long term. It also just so happens that both are among Buffett’s largest holdings at Berkshire Hathaway -- in fact, Wells Fargo is Berkshire’s single largest stock holding. While neither stock is as cheap as it was circa 2009, both are still reasonably priced for a long-term owner today.


Ref:  Warren Buffett's Greatest Wisdom