Warren Buffett has been a great teacher. He has shown me and countless others a better way to think, behave and invest. Among the many great things about him is the way he has evolved in his thinking and his approach to investing.

So if I question what he said it is because I want to understand better.

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In the 1994 annual letter to Shareholders Warren said

It’s far better to own a significant portion of the Hope diamond than 100% of a rhinestone…

Let’s pick apart this idea.

Hope diamond is a metaphor for a wonderful business that has a very high return on capital with a moat like Coca Cola or See’s Candies. Rhinestone on the other hand is a mediocre business with low return on capital and no moat. So Warren is saying that it is better to be a shareholder of Coca Cola than say a mediocre business.

I have at least 3 arguments against it.

#1. Rhinestones may evolve into Hope Diamonds.

Berkshire Hathaway was a mediocre textile business in the early 60s…if you called it a Rhinestone you would be generous. But Buffett himself transformed it into a Hope Diamond through superior capital allocation. (He took the cashflows from the textile business and invested it in insurance and used that to buy better and better quality businesses.) If somebody from the early 60s got hold of my blog, imagine how much money he would make.

I know of many, many, many such case studies in India where a son or daughter, a new CEO or a new owner comes and starts allocating capital more efficiently and turns a failing business to a fantastic business. These turnarounds create fantastic amount of wealth for their shareholders. A few of these have gone on to become 100 or 200 baggers or more. Think Eicher Motors or Bajaj Finance.

The key is to look for patterns – change in product mix, change in distribution, improved cash flows, improved margins, reduced debt, sale of non core assets, exiting unviable businesses etc., etc.

If you say “But Buffett said it’s better to invest in Hope Diamond“… you will miss Buffett himself, not to mention all other opportunities.

#2. What if you got to buy a Rhinestone for the price of dirt

Once in a while, you may find Rhinestones at the price of dirt. Or what is called Cigar Butt investing. A mediocre company may experience a one time windfall which may benefit the shareholders. You have to think and behave like a mercenary and exit the business (and not fall in love with the stock).

You will find such opportunities in commodity and commodity like businesses like say hotels. (Just so you don’t think I am making it all up- I am currently owning shares of a company whose market cap is x, but which owns liquid assets far more than x. And you will be kind if you called this company a Rhinestone or even a stone.)

#3. What if you got paid to take Rhinestone off somebody else’s hands

But in his book “The Dhandho Investor”, Mohnish Pabrai talks of banks ending up with failed hotel properties as NPAs. The banks are eager to get rid of the property because they will have to provide for it and hence their reported profits will be lower which make shareholders unhappy. Because of the high NPAs, the banks’ cost of borrowing goes up etc. In short, the banks are extremely eager to get rid of such NPAs. And smart businessman will buy such distressed properties and get the bank to lend them money as well. So not only are they buying a property at a fraction of it’s market value, they are getting cheap loans to refurbish it and run it as well.

HOEC is an oil and gas company. The owners were eager to exit the business. Two guys went and purchased the company from the owners and they got them to waive off Rs 1000 Crs of debt as well!

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My point of this blog is that Warren Buffett’s context is different from mine. He has hundreds of Billions of dollars available to invest as of today and by next year he will have even more. Therefore he has to invest large sums of money for long periods of time. Hope Diamond is his only hope.

My context is that I have far, far smaller sums of money to invest and therefore I have no constraints like him. And therefore I can invest freely in Hope Diamonds, Rhinestones and maybe even stones – as the opportunities come.

It’s kind of like the old Akbar-Birbal joke. Birbal told Akbar: “my lord, there are things that you can do that even god cannot“. All the the other courtiers laughed and told the emperor that Birbal is openly and unashamedly flattering the emperor. To which Birbal said “my lord, your can banish me from your empire. But the whole universe is god’s empire and therefore he cannot banish me from it“.

So just as large size is an advantage, small size can also be an advantage. Warren Buffett is one of my heroes; he is wise, super successful and one of the richest men ever. Yet there are things you and I can do that he can’t. So his size doesn’t allow him to look beyond Hope Diamonds. My size does and maybe yours does too.

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So if you asked -“Would you rather be a part owner of a Hope Diamond or a 100% owner of a Rhinestone”?
I’ll say: “I’d rather be rich”.

-Cheers