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Warren Buffett’s Plan to Beat the Market

One of the ironies about Warren Buffett's philosophy on investing is that, while he recommends that most investors can't beat the broader market and should therefore only invest in low-cost index funds, his model at Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) presupposes that he'll be able to. And for the most part, he's been right.

How does Buffett accomplish this? As Gaby Lapera and John Maxfield discuss in the latest episode of Industry Focus: Financials, he waits until corrections in the market before he really begins to pour Berkshire's cash into stocks.

A full transcript follows the video.

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Gaby Lapera: I want you to do one thing for me before we get on to the next Buffett thing, which is, pick out a quote that really stood out to you in this letter, and tell me about it.

John Maxfield: Oh my God, I'm so glad you asked me that. We didn't prep for this ahead of time, but I have one for you, Gaby! It's your lucky day, it's your birthday a week and a half early!

Lapera: Thank you; this is what I've always wanted!

Maxfield: So in the conversation of the letter, in the very beginning of it, the first two paragraphs of Buffett's conversation -- and when you're a guy like Buffett, he is so smart, he knows how to order his letters. So there is significance to where in the letter certain things fall. And the closer to the beginning, they're probably pretty important. So he spends the first two paragraphs talking about this fact that, because they're getting so big, their returns aren't going to blow out of the market every year like they used to. But then, in the third paragraph, after teeing that up, he talks about the fact that, what you're going to see with Berkshire is that our returns are going to be lumpy. There are going to be some years where we have huge returns. It's in this context that he says this quote. "Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying wash tubs, not teaspoons. And that we will do." So, what he's basically saying is that, "Look, we have accumulated an enormous amount of cash," and I don't have it off the top of my head, but, tens of billions of dollars' worth of cash that they're waiting to pool in on investments. And basically, what he's saying is, at this point, now, they're just waiting for that opportunity.

Lapera: Yeah. Which will maybe give them a little spike above the S&P 500.

Maxfield: That's exactly right. But it also speaks to where Buffett's brain is at, in terms of what he's thinking about the market. We know that the market has corrections regularly. Warren Buffett is basically saying, "I'm waiting for a very large correction." So you can work backwards from that.

Lapera: Yeah, which will be really interesting. Maybe some of these gains that we've seen, the "Trump bump" as some people are calling it, might be washed away. But that's also just the nature of the market.

Gaby Lapera has no position in any stocks mentioned. John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.