Warren Buffett Investment Strategies Past & Present
In our second look at Warren Buffett we examine how and why he makes the investments that he does. As the worlds greatest investor everyone wants to know the secret to his investment decisions. Terms like "value investor" and "intrinsic value" are often associated with Warren Buffett, but very few people know what they mean or understand how they relate to a publicly traded company. Warren Buffett wasn't always the buy-and-hold investor we know today, his investment style has matured over time. We take a look at some of Warren Buffett's investment terms and strategies in hopes that it will help the average investor get a leg up in the stock market.
The Last Pull of the Discarded Cigar Butt
Before Warren Buffett became the sage buy-and-hold investor we know today, he was more of a quick profits type of investor. He relied on a strategy that was short term in nature but profitable for him. The last pull of the discarded cigar butt strategy was applied to a company whose stock he felt had one more good run in it. Buffett compared companies with cheap stocks in bad businesses to discarded cigar butts with one last puff. The discarded cigar wouldn't be pretty, but getting that last puff was relatively free for the person that picked up the cigar. Applying that idea to investing he looked for cheap companies that had one last puff for the investor who purchased the companies stock. Once the last puff was taken there would be nothing more to gain and the stock would be sold at a profit. The 1962 investment into Berkshire Hathaway was a "Last Cigar Puff" investment. The Berkshire's business had been in decline and the company had been making tender offers for it's shares. Buffett made the investment with the hopes that Berkshire Hathaway would make a tender offer of $11.50 per share, being the company's last puff. This was a relatively success investment strategy for Buffett in his early days.
"I don't want a business that's easy for competitors. I want a business with a moat around it with a very valuable castle in the middle. And then I want the duke who's in charge of that castle to be honest and hard-working and able. And then I want a big moat around the castle, and that moat can be various things." - Warren Buffett
The Moat is Warren Buffett's one word term for competitive advantage. When he discusses "The Moat" of a company, he is talking about what separates the company from it's competitors. Things like consumer loyalty, expensive barriers of entry, low prices are just a few things that can make up a moat. In the same interview where I pulled the quote above Buffett discuss the moat around GEICO, which was/is its low prices. As I've studied GEICO in the past I've come to agree with Buffett's assessment of GECIO's moat. The company prides it self as a low cost provider. By keeping cost and expenses low they are able to pass on the savings to the customer. The company attempt's to underwrite only the best drivers to keep claims and payouts low versus other insurance companies who will insure almost anyone and charge them a premium related to their degree of risk. Unlike some of the other insurance companies out there GEICO makes money from its underwriting. That means for every dollar it brings in from premiums it sees a profit from that dollar. If you recall from our first discussion on Warren Buffett we examined briefly how insurance companies pool premiums and invest it for returns. Some insurance companies rely on this model primarily for profits. Not GEICO, they make an underwriting profit and couple that with investment returns. A low cost provider, insuring the best drivers, and making profit from the premium it collects, as well as investment profits is a pretty nice moat.
Some people have accused Buffett of investing in and promoting monopolies. However, this is a part of the competitive advantage. When analyzing a company it's always a good idea to look at what would allow the company to reach massive success and on the flip side massive failure. If laws or regulations are put in place that will allow a company to achieve massive success, why wouldn't an investor invest in such a company? It all goes back to the company's competitive advantage, whether it is created by the company or the government a professionals investor's duty is to find it and make the investment.
Assets/Share, Cash/Share, Investments/Share, Cash Flow/Share, Value Investing.
In our research of Warren Buffett's investments we came across information like this from the Warren Buffett wikipedia page, "In 1965, when Buffett's partnerships began purchasing Berkshire aggressively, they paid $14.86 per share while the company had working capital of $19 per share." Here is another from oldschoolvalue.com, "He (Warren Buffett) explained to the partners that in 1958 Sanborn was selling at $45 per share when the value of its investment portfolio itself was at $65 per share which meant that it was undervalued by $20 per share with a map business coming in for nothing." This concept is explained in Benjamin Graham's investment bible 'Security Analysis.' In 'Security Analysis' Graham spends hundreds of pages discussing the idea of intrinsic value and value investing, but never gives the reader a formula or model on how to calculate the intrinsic value of a company. What the reader does get is that the concept of determining intrinsic value is more art than science, comparisons like weighing a companies assets per share against its debt or liability per share appear throughout the book. Understanding a company's intrinsic value is what sets Warren Buffett apart from other investors professional and novice. He has a great sense for detecting value in the markets.
Buying America and Holding it.
Warren Buffett has long stated that if you believe in America, then you should buy American companies. He doesn't just say it, he practices what he preaches. Coca-Cola, American Express, IBM, Dairy Queen, Fruit of the Loom, The Kraft Heinz Company, are just a few American based business that have done well for Warren Buffett and Berkshire Hathaway.
Berkshire Hathaway under Warren Buffett has avoided investing in technology companies in the past. Buffett has admitted publicly that he doesn't understand them, and he does his best to stay away from things he doesn't understand. However, recently he has revealed a large purchase of Apple shares on the open market. The reason for his investment in the consumer tech giant? Consumer behavior. While he admits to not understanding tech he does understand consumer behavior, and in Apple he sees a company that produces products that consumers have consistently been willing to pay a high premium for. Remember the quote from our last article on Warren Buffett about why he purchased Coca-Cola? Well that same thought process can be applied to Apple. There is an iPhone, iPad, Mac, or Apple Watch being purchased at every hour of the day all over the world.
Index Funds for the Novice Investor.
Why does the world's greatest stock picker recommend index funds? Because he understands the time it takes to vet a company and the work required to maintain a profitable portfolio. In the 2004 Annual Berkshire Hathaway meeting Buffett had this to say about index fund investing.
"If you like spending 6-8 hours per week working on investments, do it. If you don't, then dollar-cost average into index funds. This accomplishes diversification across assets and time, two very important things."
In the same meeting when asked where to invest Buffett replied,
"We never recommend buying or selling Berkshire. Among the various propositions offered to you, if you invested in a very low cost index fund -- where you don't put the money in at one time, but average in over 10 years -- you'll do better than 90% of people who start investing at the same time."
And if you were wondering what index fund the Oracle of Omaha would recommend he answered that to saying,
"Just pick a broad index like the S&P 500. Don't put your money in all at once; do it over a period of time. I recommend John Bogle's books -- any investor in funds should read them. They have all you need to know. Vanguard. Reliable, low cost. If you're not professional, you are thus an amateur. Forget it and go back to work."
While index funds isn't particularly a strategy that Warrant Buffett uses, it is one he recommends for the novice or amateur investor. If you are someone with a 9 to 5, and the last thing you feel like doing after work or on your weekends is reading through annual reports and looking at stock charts, then an index fund is for you. An index that tracks the S&P 500 gives an investor a diversified investment over 500 of Americas best companies. As American companies grow, the country grows, the S&P 500 increases and so will any investment in an S&P 500 index fund. It's a pretty simple formula.
Using the Information Available for Profitable Investing.
The one last cigar puff to value investing to buying and holding American companies to investing in consumer behavior. While these seem like separate strategies they aren't. While an emphasis may have been on one strategy, the others were always incorporated into the investment research. While the Berkshire Hathaway investment was a last cigar puff with the hopes of a tender offer from the company, when the tender didn't happen as Buffett planned, he saw the company had a working capital of $19 per share while the stock sold at $14.86 per share. This gap between the price per share and the working capital per share is where Buffett saw value, which gave him the confidence to purchase a majority stake of the company. With Coca-cola in 1988 Buffett saw value and a company with a product that appealed to consumers.
Buffett's strategies and how he looks at investing has changed over the years, which is something all investors should keep in mind. What works in 2018 may or may not work in 2028, so it is important to be flexible when assessing a potential investment.
We hope that this adds value to your investment approach, thanks again for checking out The Seville Report, and may your next investment be your best investment.