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May, 2014


Berkshire Hathaway (BRK/A; BRK/B), the failing textile company that Warren Buffett turned into a giant S&P 500 conglomerate, held its annual shareholders meeting on 5/3/14. Over 40,000 attended. Had you bought just a single share of BRK back in 1962, when Buffett began accumulating the asset as a low price to book value bargain, and held onto it through the last trading session (5/2/14) before this year's annual meeting, your initial $7.60 investment would have been worth $192,255. The duo of Warren Buffett and his brilliant mentor, Benjamin Graham, are perhaps the best known exponents of value investing. Together their careers span more than 90 years. Yet Buffett credits his investment success not just to his former Harvard teacher and later employer, Graham. Later he came to be much influenced as well by Charlie Munger, now his Berkshire Hathaway Vice-Chairman, and by Philip A. Fisher, who advocated winning the investment game via equity growth strategies.

Ordinary and institutional investors who use the original, strictly Benjamin Graham approach probably invest only a few billion dollars a year. If much larger amounts were to pour into value methodologies, laws of supply and demand would almost certainly force the prices of candidate stocks up so high that they would cease to be bargains, and so this technique would no longer work.

Buffett's and Berkshire Hathaway's challenge, once the company began to be substantially larger and to generate billions of dollars in profits annually, was to find ways to still invest such significant sums without losing most of his return on equity. He did it by acquiring so-called "growth companies" when they were selling at a big discount to their intrinsic value. At first, though, he balked at this. It was not what Benjamin Graham had taught him.

Thanks to Philip Fisher and Charlie Munger, he eventually came to see that there need not be a distinction between value and growth investing. The trick was to get the growth at the correct (i.e. value) prices. This, in turn, involved a switch from looking at how much quantitative book value a company had at the time of purchase (based on its performance in the past) to how much qualitative intrinsic value it had (based on estimates of the income it could reasonably be expected to produce over the course of the next several decades).

The former, more firmly value investing method was limited in its upside. Value investments have been called "cigar butt" assets, having enough cash per share, compared with their current prices, that it is reasonable after awhile that investors will realize the potential and bid shares up, perhaps 50 or 100% or so, to how much they are really worth given already discernable net assets. They are thus like finding a cigar butt on the sidewalk. One can carefully light them and get maybe one or two free puffs each out of what somebody else has thrown away. This technique of investing works well for small investors (like most of us) who can buy shares of typically low market-capitalization stocks without driving up their prices.

However, the latter, or growth at value prices, approach is more like buying shares of Coca-Cola (KO) in the early 1970s when markets had endured steep dips and one could, as BRK did, buy huge amounts of future KO profits for a small enough amount that future returns on equity were bound to be in the high double-digits. With its market share dominance, Coke was not going anywhere but up in the years ahead. People were not going to stop buying sweet, carbonated beverages. Quite the contrary, as KO expanded its operations overseas, the growth company's profits would simply balloon.

Warren Buffett with Alice Schroeder (Wikipedia)

Variations on this theme for BRK have now included buying not merely stock shares but entire companies worth billions in earnings a year, recently, for instance, BNSF, Burlington Northern Santa Fe Railroad.

Even so, the sky is no longer the limit for Berkshire Hathaway. Yes, it is almost certain to keep growing, in the process absorbing more and more exceptionally lucrative companies, but BRK's average rate of growth cannot keep pace with its own stellar record of almost 20% a year. If it did, it would need eventually to swallow up the whole solar system, comets, planets, asteroids, the entire sun, the billions of icy planetoids in the oort cloud, all of it, then move on until, like a vast black hole, it would next consume the whole of the Milky Way galaxy. Instead, Berkshire Hathaway will likely keep doing well, probably very well, besting the average returns of the S&P 500 Index, but at a slowing pace of superior advance.

A summary of successful principles suggested by these investment geniuses follows:

Benjamin Graham

  1. Only invest when strong balance sheets plus net value make one's purchases worth a lot more than one is paying for them.

  2. Keep a margin of safety, the difference between the (lower) cost of an equity and its (higher) intrinsic value. When a stock loses its margin of safety, so that its price is now greater than its true value, it is time to sell.

  3. Most of the time, hold a substantial portion of one's liquid funds back in relatively low-risk securities, such as short-term bonds, so one will be able to invest at better bargain levels when stocks periodically fall into disfavor.

  4. Rebalance holdings regularly, for example once a year, so that if stocks have advanced but bonds have languished (or vice versa) one can sell some of the former at a profit and buy more of the latter at a discount.

  5. The stock market, "Mister Market," is highly irrational, sometimes quoting stocks at way more than their intrinsic values and at other times for far below what their shares are truly worth. The wise investor will take advantage of these swings, buying low and selling high. By contrast, the typical investor is swayed by these surges and retreats, greedily buying more when prices are up, fearfully selling out when they are going down. Thus on average he or she frequently buys high and sells low.

Philip Fisher

  1. Focus investments in a handful of exceptionally good companies.

  2. Find these enterprisers via what the best of their competition's managers say about them or, in general, via a superior network feeding one intelligence about the businesses that will do well through thick and thin.

  3. Select only the best of companies for investment using assessments of their qualities of leadership in human resources, financial accounting, adaptability, high business standards control, accessibility to potential shareholders, honesty, and farsightedness.

  4. Select them as well based on such business criteria as command of a market niche, good return on capital, superior research and development, excellent profit margins, above average sales efforts, and a continued growth outlook.

  5. Hold shares in such outstanding companies for the very long-term.

Charlie Munger

  1. Always be carefully investing in something. To do this, spend less than you earn. Put the difference into your nest egg, preferably in tax-deferred accounts. Over time, one's net asset value will do very well.

  2. Getting into debt is not a good idea. If you do have debt, pay it off or at least keep payments current until you can.

  3. Think of investing in stocks the way you would consider taking partial ownership in a well run business. Do not be too quick to get in. But once you are sure it is a good company and have taken the plunge, also do not be too quick to get out.

  4. Keep overhead low, really, really low, and profits high, really, really high, and prize managements (like at Berkshire Hathaway) that do the same and that pass their profits along to their shareholders.

  5. Once one has accrued a pile of cash (or cash equivalents) do not be too eager to get rid of it. A pile of cash is hard to come by. Make certain the movie about where you put it is going to have a happy ending.

Warren Buffett

  1. While investing is better than not investing and good investing is better than bad investing, above all else, as Buffett says: "Rule number one is never to lose money. Rule number two is never to forget rule number one."

  2. Companies in which to invest should be understandable, demonstrate profits via positive cash flow, not require an intellectual giant to run them, and have predictable earnings, a controlling market share or business franchise, good return on capital, and little debt. They ought to also have owner-oriented policies, assuring sustained proceeds for their shareholders.

  3. Only occasionally is a great business for sale in the stock market at a fantastic price. Be prepared when that does occur to load up the truck! Then hold onto those shares as long as the enterprise remains superior.

  4. Market gyrations should be viewed as your friend. Use them to buy the best at going-out-of-business sale prices, never an excuse to sell wonderful enterprises just because their shares are going down in price.

  5. Once one has been especially successful, be ready as well to be singularly generous.

For more on Benjamin Graham, Philip A. Fisher, Charlie Munger, and Warren Buffett, the following are terrific works:

  • Benjamin Graham's The Intelligent Investor

  • Carol Loomis's Tap Dancing to Work: Warren Buffett on Practically Everything, 1966 - 2013

  • Janet Lowe's Damn Right: Behind the Scenes with Berskshire Hathaway Billionaire Charlie Munger

  • John Train's The Money Masters

  • Philip A. Fisher's Common Stocks And Uncommon Profits


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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