Beware Buffett?

If you've been paying attention to the markets recently, you would know that Warren Buffett recently bought shares of the struggling Bank of America. While it makes sense in theory to follow the investments of a man who has been dubbed the Oracle of Omaha, it doesn't, however, seem like the best investment.

It does give a certain credibility to the stock and the company:

"This helps with the credibility gap that I think has existed in the minds of some shareholders. It reiterates the point that the balance sheet is healthy. They needed an endorsement in the market and they got it," said Jon Finger, managing partner of Finger Interests in Houston.

It does not hide the fact that the company is in some sort of trouble. People put money into these companies because of Buffett's track record and his name. However, you're not getting the same deal that Buffett is getting. Before we get into the actual deals, consider this; you're buying after Buffett buys, probably at a higher price than Buffett, and you're selling after Buffett sells, probably at a lower price than Buffet. This means you're getting lower returns to begin with.

Then you have the real reason Buffett is investing: he's getting a great deal on the investment:

Now Buffett is investing in beleaguered Bank of America. He invested $5 billion in a special preferred stock and will be getting a 6 percent dividend, while the regular stock you can buy pays less than 1 percent. Now I don’t know whether Bank of America is a good deal at current prices. Maybe it is. But the point is, if you buy now, you’re not getting the same terms as Buffett. You’re just pumping money into his dividend payment and hoping for the best.

And it's not the first time he's gotten this type of deal; he did it with Goldman:

But Buffett had more than $12,000 to invest. He had $5 billion. So he negotiated a much better deal. He bought preferred stock that came with a special dividend. Instead of 1 percent, he negotiated a 10 percent dividend. So now every year he receives a check for $500 million. Then, only after he gets paid, do common stockholders get their paltry 1 percent.

He did it with General Electric:

Buffett made a similar deal with General Electric. In 2008 he bought $3 billion in preferred shares with a 10 percent dividend. But you wouldn’t have done well to follow him. The stock was selling at around $21 a share in the fall of 2008. Now it’s running between $15 and $16, a loss of over 20 percent. But remember, unlike regular investors, Buffett’s been collecting that 10 percent dividend. He’s still ahead of the game.

Even when the stock was losing, Buffett was gaining. Does this sound like the kind of deal you want to get into?

Buying preferred shares is different from buying common stock. Investing in preferred stock has its advantages:

A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights.

The precise details as to the structure of preferred stock is specific to each corporation. However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as "preferred shares".

Buffett is essentially getting a much better deal than those of us who invest in common stock.

Following Buffett might have its advantages. Bank of America shares surged on news that Buffett had invested in the company. However, you need to realize that you're investment returns will be different from Warren's and your needs might not be the same as a result. He has built in advantages which will enable him to make a lot of money. These advantages are not available to the general public. It's important to see through to the details before making an investment following someone like Warren Buffett.

I'm not saying following Warren Buffet is a bad idea. I just think its important to know what you're getting into and how your returns might not be what you expect. The most important thing in investing is information: make sure you know what's going on.