Buffett Tells Us the Biggest Mistake You Can Make in Stocks

In a relatively broad, multi-topic interview that Berkshire Hathaway’s Warren Buffett gave on the CNBC a while back, he told the world what he believed to be the biggest mistake individual investors could make in relation to buying and selling stocks.

During this interview, he stated:

“I think the worst mistake you can make in stocks is to buy or sell based on current headlines.”

These words of wisdom came from Buffett while Europe’s debt crisis was in full swing and many an investor was starting to seriously doubt the possibility of an economic recovery. On that day, the S&P 500 was only 1350. Since Buffett spoke those words, it has gained over 30% in value.

The Ultimate Lesson from Buffett’s Words of Wisdom

We are in a culture where headlines often grab one’s attention, and advertisers in the media are always looking to make the public pay attention. When Warren Buffett speaks, his advice is something that people should take seriously.

Often times we are inundated with too much information. We neglect to realize that the media headlines and latest fads should not dictate the way that we invest. We need to take the immortal advice of Warren Buffett and think about where a company is going to be 10 or 20 years from now, and forget about the day-to-day things that happen. As long as nothing fundamentally changes, everything should be fine.

Please consider Warren Buffett’s investment with Bank of America in August 2011. The following headlines made the news two weeks prior to the announced deal:

  • on August 8, 2011, the headline read: Bank of America stock plunges 20% (CNN)
  • on August 8, 2011, the headline read: BofA plunges as AIG sues for $10 billion “fraud” (Reuters)
  • on August 18, 2011, the headline read: BofA Says Some Debit Cards Compromised (Bloomberg)
  • on August 22, 2011, the headline read: Bank of America stock takes a beating… again (CNN)
  • on August 23, 2011, the headline read: Here’s why Bank of America Stock Is Collapsing Again
  • on August 23, 2011, the headline read: Wall Street’s Rumor of the Day: JP Morgan Taking over Bank Of America (Forbes)

As a matter of fact, from August 1, 2011 to August 23, 2011, Bank of America’s shares dropped an astounding 36%. The share price went from $9.81 per share to $6.30 per share.

According to the Business Insider story, the main reason for the dramatic fall in the bank’s stock prices was “fears that Bank of America will go bust, taking the whole economy down with it.”

Do you see the big problem here? The problems didn’t necessarily originate from Bank of America, but came from the people who covered this story within the media, and also those who traded shares. The overall business didn’t experience any fundamental changes during that rough three week period. It was all fear fueling the headlines, and this no doubt created even further fear.

Turning Words into Action

Buffett has no doubt been a man who takes his own words of advice. His words stating to “be fearful when others are greedy, and the greedy when others are fearful,” from the New York Times October 2008 Op-Ed are no doubt the big driving force that caused him to take action to invest $5 billion in BofA on August 25, 2011.

As you can imagine, this led to even further headlines, including: “Buffett to Invest $5 Billion in Shaky Bank of America” and also “Buffett Investment Could Erode Confidence in Big Banks.”

In hindsight, it is plain to see how wrong those headlines have been.

Berkshire Hathaway currently earns an annual dividend of $300 million from Bank of America because of its preferred shares. Additionally, the company has an option to buy more Bank of America stock at $7.14 per share. Based upon those warrants and today’s current stock prices, Buffett and Berkshire Hathaway could see a 120% return on investment in 28 months, which equates to $6 billion.

Final Thoughts

Dealbook tells us the conversation between Bank of America CEO Brian Moynihan and Warren Buffett went something like this:

“Mr. Buffett called Mr. Moynihan to discuss a potential deal. At first, Bank of America’s chief was skeptical, saying the bank didn’t need a capital injection. But Mr. Buffett emphasized it would be a long-term investment, not a short-term fix.”

Buffett wasn’t trying to game the system and make a quick buck. He wasn’t trying to time the market or anything else of that nature. He looked past all of the headlines and saw the true value of a business like Bank of America.

In today’s world where we are basically driven by the headlines, 140 character blurbs and other things of this nature, it would be smart to realize that you should not base your investment decisions on this, and instead base them on sound principles and the right temperament.