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I've been searching the ROI percentage of well known investors:
I was wondering how can they manage to pull this off despite the fact that the average company they invest in does not even come close to a 15% annualized return.
What kind of sorcery are they using? Leverage? Preferred stocks?
Is it something that I am missing?
First of all, the annual returns are an average, there are probably some years where their return was several thousand percent, this can make a decade of 2% a year become an average of 20% .
Second of all, accredited investors are allowed to do many things that the majority of the population cannot do. Although this is mostly tied to net worth, less than 3% of the US population is registered as accredited investors. Accredited Investors are allowed to participate in private offerings of securities that do not have to be registered with the SEC, although theoretically riskier, these can have greater returns. Indeed a lot of companies that go public these days only do so after the majority of the growth potential is done. For example, a company like Facebook in the 90s would have gone public when it was a million dollar company, instead Facebook went public when it was already a 100 billion dollar company. The people that were privileged enough to be ALLOWED to invest in Facebook while it was private, experienced 10000% returns, public stock market investors from Facebook's IPO have experienced a nearly 100% return, in comparison.
Third, there are even more rules that are simply different between the "underclass" and the "upperclass". Especially when it comes to leverage, the rules on margin in the stock market and options markets are simply different between classes of investors. The more capital you have, the less you actually have to use to open a trade. Imagine a situation where a retail investor can invest in a stock by only putting down 25% of the value of the stock's shares. Someone with the net worth of an accredited investor could put down 5% of the value of the shares. So if the stock goes up, the person that already has money would earn a greater percentage than the peon thats actually investing to earn money at all.
Fourth, Warren Buffett's fund and George Soros' funds aren't just in stocks. George Soros' claim to fame was taking big bets in the foreign exchange market. The leverage in that market is much greater than one can experience in the stock market.
Fifth, Options. Anyone can open an options contract, but getting someone else to be on the other side of it is harder. Someone with clout can negotiate a 10 year options contract for pretty cheap and gain greatly if their stock or other asset appreciates in value much greater. There are cultural limitations that prompt some people to make a distinction between investing and gambling, but others are not bound by those limitations and can take any kind of bet they like.
Buffett is able to do many things the average investor cannot do.
For example: during the 2008 market crash, Buffett purchased $5 billion of Citi preferred stock (as somewhat of a bailout) that pays a 5% dividend. Then he also received warrants to buy another 700 million shares over the next 10 years where he can buy shares at 5% discount. So right off the bat he is up 5% anytime he buys some of those 700 million shares.
http://dealbook.nytimes.com/2011/08/25/buffett-to-invest-5-billion-in-bank-of-america/
This is just one of the Buffett deal makings. With his cash you can move markets. He buys, people hear about it, they buy, his positions go up. Put that aside he loans cash, gets interest, buys companies. It is more than just investing in the stock market.
It's called leverage. Here's an example from real estate.
The underlying appreciation on a house in certain parts of America is something like 7% a year. So if you bought the house "all cash," your return would be something like 7% a year. (Actually, a little more, because of the rent you would be collecting, or saving, if you were the "renter.")
Suppose you buy the same house, 20% down, 80% mortgage. The rent pays for your mortgage, taxes, insurance, etc. like it is supposed to. The house goes up the same 7% each year.
But now your rate of return is 35%, that is 7%/20% (your down payment). You get the whole appreciation but put up only 20% of the money. The bank (and your renter) did the rest.
Warren Buffett follows simple value and Growth at a Reasonable Price (GARP) tenets that literally anyone could follow if they had the discipline to do so. I have never once heard of an investment made by Warren Buffett that wasn't rooted in fundamentals and easy to understand. The concept is fairly simple as is the math, buying great companies trading at discounts to what they are worth due to market fluctuations, emotionality, or overreactions to key sectors, etc.
If I buy ABC corp at $10 knowing it is worth $20, it could go down or trade sideways for FIVE YEARS doing seemingly nothing and then one day catch up with its worth due to any number of factors. In that case, my 100% return which took five years to actualize accounts for an average 20% return per year. Also (and this should be obvious) diversification is a double edged sword. Every year, hundreds of stocks individually beat the market return. Owning any one of these stocks as your only holding would mean that YOU beat the market. As you buy more stocks and diversify your return will get closer and closer to that of an index or mutual fund.
My advice is to stick to fundamentals like value and GARP investing, learn to separate when the market is being silly from when it is responding to a genuine concern, do your own homework and analysis on the stocks you buy, BE PATIENT after buying stock that your analysis gives you confidence in, and don't over diversify. If you do these things, congrats. YOU ARE Warren Buffett.
