Stock Picks and Market Insight of Warren Buffett and John Paulson

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John Paulson and Warren Buffett share many investment philosophies, Gregory Zuckerman's excellent book "The Greatest Trade Ever" shows.

Zuckerman is The Wall Street Journal reporter who last year broke the story of the huge profits Paulson generated for himself and his hedge fund firm, Paulson & Co., by betting on a collapse of the housing market and ensuing chaos in the financial system.

Paulson made about $6 billion for himself in 2007 and 2008 mostly by buying credit default swap insurance on baskets of subprime mortgages. The CDS contracts soared in value when the subprime market collapsed in 2007. Paulson's firm then shorted the stocks of the financial companies primed to suffer in the resulting chaos.

Though Warren Buffett is only mentioned a few times in "The Greatest Trade Ever," readers who are familiar with the Berkshire Hathaway chief's investment style will pick up on the similarities with Paulson.

The commonalities jump right off the page in this passage of Zuckerman's prologue:
"Paulson was no singles hitter, afraid of risk. A part of him had been waiting for the perfect trade, one that would prove him to be one of the greatest investors of all. Anticipating a housing collapse -- and all that it meant -- was Paulson's chance to hit the ball out of the park."

Buffett frequently uses the baseball analogy to counsel investors on "waiting for the fat pitch." He advises investors to wait patiently for the "pitch" they can drive out of the park rather than wasting their time and money on lesser opportunities. When that pitch comes, Buffett says, swing away.
That's what Paulson did when he saw the impending collapse of the housing market, throwing most of his firm's capital on a bet that transformed his reputation to one of the shrewdest minds in investing.

But the similarities between Paulson and Buffett don't stop there. Here are some of the ones I jotted down while reading Zuckerman's book this weekend.
1. Long hours of intensive, solitary research leads to conviction on investing ideas that allows the men to go against conventional wisdom.

2. Reliance on reading, independent thought and common sense rather than computer models.

3. Avoiding flashiness with wealth both at the office and personally.

4. The love of numbers and ability to explain complex financial matters simply.

5. Courage of one's convictions even when criticism sets in and trades temporarily go against them.

6. Willingness to be early on the investment and take some short-term losses if they know it will prove correct in the long-term. (Fairholme's Bruce Berkowitz cleverly calls this "premature accumulation.")

7. Love of business from a young age -- Buffett sold Cokes, Paulson sold Charms candy.

8. Self-deprecating sense of humor.

9. Focus on downside risk of investments -- thinking about what can go wrong and choosing investments with limited downside and huge upside.

10. Love of work for its own sake even when money is no longer needed.

11. Early struggles to attract investor money due to outsider status.

12. Willingness to admit mistakes and learn from them.

13. Understanding of the magic of compounding.

14. Focus on getting value.

15. Attachment to investments made.

16. Keeping investment ideas close to vest, even to fellow partners and investors.

17. Portfolio heavily concentrated on best ideas.

18. Early losses seen as opportunity to buy more, not run for the hills (Zuckerman shows how hard it is to stand tall in the face of early losses, however, both because of pressure from fellow investors and because it takes lots of capital to continue on. There were many others who saw the same opportunities that Paulson did but were unable to cash in because of insufficient capital and/or conviction).

19. Focus on making money during career and giving it away afterward. More money can go to charity in the long-run by compounding it during one's career. Focus philanthropy not on putting your name on buildings.

20. Flexibility -- going where the best opportunities are rather than relying on dogma.

21. Bearishness on U.S. dollar and worry about inflation.

Undoubtedly there are more similarities, but that's a good start -- and a great book.



William Freehling, who owns Berkshire Hathaway "B" shares, is a business writer for a newspaper in Virginia. He closely follows the moves made by Warren Buffett and his company. He has read widely on Buffett and the billionaire's beliefs on value investing. Bill can be contacted at freehling@hotmail.com

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