Monday, April 13, 2009

The Lunacy of Ratings Agencies and Warren Buffet

I would place bond-rating agencies, such as Moody’s, in the same boat as economists and weather forecasters, both of which are well known for not being very accurate in their predictions, but closely watched and given significant status, nevertheless.

Despite a rock-solid balance sheet, Warren Buffett’s company Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) lost its triple-A rating recently, with Moody's downgrading the company. As a contrarian, I think this announcement contains a hint of optimism and here's why:

Said without any sugar-coating, Moody's and its main competitor Standard & Poor's have had (and still have) a dismal record of predicting past and current developments “in advance of the results”. These ratings companies have a stellar track record of confirming what has already taken place, with the typical accompanying lower valuation of a company’s stock price already occurring prior to their downgrade of the company. In weather forecasting terms, they are great at confirming where the tornado touched down, after it as knocked down the homes, but poor at informing investors of where the financial tornado may hit, in advance. Instead of “fore”casting, I think a better term would be “after”casting.

As it pertains to Mr. Buffet’s Berkshire Hathaway, the recent downgrade is a classic contrarian buy signal. In the mutual fund I manage, we are increasing our stake in (BRK-B) as a result!

For most individual investors, buying (NYSE: BRK-B) at a current share price of $3,072 (4/13/09) is simply not prudent, as the high share price requires a portfolio of at least $60,000 to allow this stock to be no greater than 5% of total portfolio assets. Prudent diversification principles suggest that any individual stock not comprise more than 5% of an investment portfolio.

Investing lesson: never place weight on people/companies that are really great at telling you where the storm has hit, but very poor at informing you of the need to seek investment shelter in advance.

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