Warren Buffett

63 Pages·2016·5.04 MB·English

Understand the world’s greatest investor in a whole new way

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Table of Contents

1.
Have You Been Sucked Into The Warren Buffett
Trap?
-P. 3-

2.
10 Reasons I Won’t Go To Warren Buffett’s 2016
Annual Meeting
-P. 19-

3.
What Warren Buffett Won’t Say: Berkshire
Hathaway Annual Meeting 2016
-P. 27-

4.
Are Warren Buffett’s Great Companies Great
Investments?

-P. 31-
5.
How a Young Warren Buffett Started His Fortune
-P. 40-

6.
How The Small Investor Should Manage His
Money

-P. 51-
7.
One Hell of a Net Net Stock: Warren Buffett One
WesternInsurance Securities Company
-P. 54 -

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Have You Been Sucked Into The
Warren Buffett Trap?

Warren Buffett is a legend among value investors — and
for good reason. His investment record is unmatched by
any other investor who existed in the last 100 years. Value
investors, understandably, have tried to emulate Buffett's
approach to investing in order to snag a sliver of his
returns. This typically means being glued to CNBC in the
hopes of catching an interview, pouring over a mountain of
books written about him, or combing through Warren
Buffett's annual letters for nuggets of wisdom.

Unfortunately, trying to emulate Warren Buffett has led
investors to adopt a less than ideal strategy.

Don't get me wrong. I like Warren Buffett — a lot. I think he
has a lot to teach investors. I appreciate his frank
communication style and his generosity as a financial
teacher. I just don't think that his contemporary investment
style, one based around buying very profitable large cap
companies with sizeable moats at fair prices, is the best
strategy for people like you and me. Blindly adopting it
after watching TV interviews, reading a couple books
about the man, or taking a peek at his past record
constitutes falling into the Warren Buffett trap. If you're
sitting on a portfolio of less than $10 million USD then —

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as those who have signed up to receive free net net stock
ideas ultimately know — there are a lot better ways to
make money in stocks.

Golden Nuggets From Warren Buffett

Now, I'm not trying to tell you that Warren Buffett is full of
crap. Warren Buffett is incredibly intelligent with a far
better investment record than I have (and, coincidentally, a
lot more money, too) so I'm not trying to say that I know
better than Buffett when it comes to investing. That would
be silly. But, there is a large body of material out there in
the form of interviews, his own articles, as well as his
shareholder letters, and all of that has to be made sense
of.

Let's start with the major pieces of advice that you should
be taking from Warren Buffett. Buffett came from the
Benjamin Graham school of investing and even today
embraces most of its philosophy. Graham taught investors
for years, for example, that a stock is just a fractional
piece of ownership in a business. Its value is derived in
large part from that business so a huge driving factor in
earned capital gains when investing in stocks is tied to the
performance of the underlying business. Warren Buffett
still echoes that same principle. In his words:

“If a business does well, the stock eventually follows.”

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I totally agree.

This also implies that a stock will fluctuate around it's
intrinsic value, the business value that the stock
represents. When taking the two investment principles
together, it's pretty clear that volatility should be seen as a
gift, something to take advantage of. This is exactly what
Benjamin Graham's Mr. Market analogy highlights, an
analogy Buffet has used many times in the past.

Warren Buffett's suggestion that you stay within your circle
of competence is great. Having well defined boarders is
really valuable when it comes to investing and will
ultimately lead to better returns. Sticking to what you know
means making fewer costly mistakes.

Speaking of mistakes, my favourite piece of advice Warren
Buffett ever gave was his suggestion to follow two simple
rules: 1. don't lose money, and 2. never forget rule number
one. This piece of advice comes into my own investment
strategy in a very powerful way, which I'll talk about more
in a bit.

These are just a few nuggets of gold from Warren Buffett,
and all are consistent with the principles that Benjamin
Graham originally taught decades earlier.

The Warren Buffett Way

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But, while Warren Buffett still embraces the fundamental
philosophy of Benjamin Graham, he obviously employs a
much different investment strategy than Benjamin Graham
argued for years before. In fact, Warren Buffett's
investment style has shifted considerably since the 1950s.
Rather than look for classic Benjamin Graham value
stocks as he did when he ran his investment partnership,
Warren Buffett has turned to finding good businesses at
decent prices. His stock selection process has become
very simple and now consists of only 4 filters. Charlie
Munger, Warren Buffett's partner in crime, sums it up this
way:

“We have to deal in things we're capable of understanding,
and then, once we're over that filter, we have to have a
business with some intrinsic characteristics that give it a
durable competitive advantage, and then, of course, we
would vastly prefer a management in place with a lot of
integrity and talent, and then, finally, no matter how
wonderful it is it's not worth an infinite price so we have to
have a price that makes sense and gives a margin of
safety given the natural vicissitudes of life.”

I'm convinced that as those on the top of their game
develop more skill and experience they are able to pack a
lot more of their philosophy, tactics, or strategy, into their
explanations, and use increasingly simple language to do
so. Despite how simple Charlie Munger's description is,
there's a lot packed into these principles that would have

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to be unwound for a thorough assessment of the Warren
Buffett & Charlie Munger investment style. This is
obviously beyond the scope of this article, but Munger's
simple explanation goes a long way to identifying exactly
what the pair do when selecting stocks.

Other soundbites and quotes fill in some of the missing
pieces:

“It's far better to buy a wonderful company at a fair price
than a fair company at a wonderful price.”

Buffett has turned to buying exceptional companies over
the cheap marginal firms he once bought. The focus is
very much on buying high quality businesses at adequate
prices — often a price far above what Benjamin Graham
would have paid.

“Our favourite holding period is forever.”

…and…

“Only buy something that you'd be perfectly happy to hold
if the market shut down for 10 years.”

Warren Buffett also holds his investments for an
exceptionally long time — far longer than the bulk of every
other "long term" Wall Street investor. While some
professional managers talk about holding on to stocks for

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months or years, Warren Buffett talks about holding onto
his investments for decades or for life.

Warren Buffett's popularity has attracted many new
investors to the value investing philosophy. These
investors typically get their first experience with value
investing through the lens of Warren Buffett's
contemporary investment style. Now long time value
practitioners are witnessing an ocean of new value
investors who seem to think that the best strategy for
success is to buy firms with deep moats at adequate
prices and to hold them forever. Typically this means
buying medium or large cap companies that have been in
the spotlight for years — firms with market capitalizations
that reach well beyond a billion dollars.

Unfortunately, this strategy is far from ideal, and could be
outright dangerous.

Is Warren Buffett's Current Strategy Dangerous?

Well, not exactly. It really come down to who is trying to
use Warren Buffett's current strategy.

As simple as the strategy sounds, actually employing it
successfully is very difficult. Warren Buffett and other
money managers, such as David Winters, draw on their
long experience in researching and investing, as well as a

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business acumen oceans deep, to employ the strategy
successfully.

Take assessing the talent and integrity of management, for
example. Warren Buffett is great at assessing people. He's
been investing for well over 60 years which means he's
read thousands of financial reports and shareholder
letters. He's also spent time managing businesses. Taking
in this much data over the course of a lifetime, and being
able to draw on practical business experience, means
inevitably being able to spot trends and draw conclusions
based on details that a typical retail investor might not
even notice.

The same goes for judging whether a business has a
strong competitive advantage or not. Of course, everybody
can recognize a competitive advantage after it's been
pointed out but picking them beforehand is a whole other
story. Warren Buffett has spent thousands of hours diving
into industry analysis and reading economic data, on top
of his experience combing through thousands of annual
reports, so his ability to spot the trends and characteristics
that make for a strong competitive advantage is far more
developed than even most professional money managers.
Think judging management or spotting strong competitive
advantages is easier than I'm making it out to be? Even
Seth Klarman doesn't think he can do it well — and
Klarman has one of the best investment records in the
industry. From an interview with Charlie Rose,

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“I think Buffett is a better investor than me because he has
a better eye for what makes a great business. And, when I
find a great business I'm happy to hold it ...most
businesses don't look so great to me.”

Joel Greenblatt is a world class investor, as well. During
his early career, by focusing on deep value and special
situations, he reportedly racked up returns even larger
than Warren Buffett did during his partnership days. On
page 49 of Greenblatt's unfortunately titled book, "You Can
Be A Stock Market Genius," he writes referring to Buffett's
contemporary investment strategy,

“The problem is that you're not likely to be the next Buffett
or Lynch. Investing in great businesses at good prices
makes sense. Figuring out which are the great ones is the
tough part. Monopoly newspapers and network
broadcasters were once considered near perfect
businesses; then new forms of competition and the last
recession brought those businesses a little bit closer to
earth. The world is a complicated and competitive place. It
is only getting more so. The challenges you face in
choosing the few stellar businesses that will stand out in
the future will be even harder than the ones faced by
Buffett when he was building his fortune. Are you up to the
task? Do you have to be?”

“Finding the next Wal-Mart, McDonald's, or Gap is also a
tough one. There are many more failures than successes.”

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Once a company is selected, it still has to be valued.
According to Warren Buffett,

“Intrinsic value can be defined simply: It is the discounted
value of the cash that can be taken out of a business
during its remaining life.”

But it's also a calculation that mere mortals have a very
difficult time using with any accuracy. It is very easy to be
off by a small margin on any one of your assumptions that
make up discounted cash flow. If you're off by more than a
hair, you will inevitably be off on your assessment of
intrinsic value by a large margin. As Buffett continues,

“The calculation of intrinsic value, though, is not so simple.
As our definition suggests, intrinsic value is an estimate
rather than a precise figure, and it is additionally an
estimate that must be changed if interest rates move or
forecasts of future cash flows are revised.”

Some investors might have the skill to be able to use
discounted cash flow with some degree of accuracy, but I
definitely don't. Before you decide to use Buffett's current
strategy, you should take a hard look in the mirror to really
admit to yourself whether you're able to perform a detailed
discounted cash flow calculation with any degree of
accuracy, yourself.

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Typically, a margin of safety is there to absorb the errors
you make, and guard against uncertainty. It's unfortunate,
then that investors who are emulating Warren Buffett are
electing to invest in wonderful companies at fair prices
rather than fair companies at wonderful prices.
Overestimating the value of a company can lead to
significant losses. Just look at Coca-cola — one of Warren
Buffett's top investments!

What is sound in theory can sometimes have very painful
consequences in practice; and, what lacks in theoretical
accuracy can sometimes yield huge dividends in practice.

Should Skilled Investors Follow Warren Buffett's
Current Investment Style?

Maybe. Clearly Warren Buffett's investment style suits
Warren Buffett, so there must be other investors out there
who would benefit from adopting his style — but that
investor is very unlikely to be you. Why? Very simply,
Warren Buffett moved away from Benjamin Graham's
investment style because his portfolio grew far to large to
take advantage of classic Benjamin Graham investment
opportunities.

Warren Buffett used Benjamin Graham's investment
strategy with tremendous success during the 1950s and
1960s. While he managed his investment partnership, he
was able to rack up the best investment results of his

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career. Buffett was able to earn returns north of 20% over
the course of his lifetime — but just look at how well he
was able to do using Benjamin Graham's investment
approach:

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Since leaving Benjamin Graham's investment strategy and
growing his managed funds his returns have significantly
decreased. Of course, you will probably bring up the point
that the increase in the amount of money he was
managing meant that his returns would inevitably suffer —
and you're rightwing. But when asked what he wold do if
he was managing small sums of money once again his
answer was very telling:

“The best decade was the 1950s; I was earning 50% plus
returns with small amounts of capital. I could do the same
thing today with smaller amounts. It would perhaps even
be easier to make that much money in today's
environment because information is easier to access.

You have to turn over a lot of rocks to find those little
anomalies. You have to find the companies that are off the
map - way off the map. You may find local companies that
have nothing wrong with them at all. A company that I
found, Western Insurance Securities, was trading for $3/
share when it was earning $20/share! I tried to buy up as
much of it as possible. No one will tell you about these
businesses. You have to find them.

Other examples: Genesee Valley Gas, public utility trading
at a P/E of 2, GEICO, Union Street Railway of New
Bedford selling at $30 when $100/share is sitting in cash,
high yield position in 2002. No one will tell you about these
ideas, you have to find them.

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The answer is still yes today that you can still earn
extraordinary returns on smaller amounts of capital. For
example, I wouldn't have had to buy issue after issue of
different high yield bonds. Having a lot of money to invest
forced Berkshire to buy those that were less attractive.
With less capital, I could have put all my money into the
most attractive issues and really creamed it.”

Notice that the examples he gives in this quote come
straight from the investment strategy of Benjamin Graham
— they're very different from the way that Warren Buffett
currently invests money. In fact, Warren Buffett often wrote
about spectacular classic Graham investments. At a
Berkshire Hathaway annual meeting held earlier this past
decade, Warren Buffett answered a question which really
spells out how he would invest if he wasn't handicapped
with a large portfolio. Take a look:

“Yeah, if I were working with small sums, I certainly would
be much more inclined to look among what you might call
classic Graham stocks, very low PEs and maybe below
working capital and all that. Although — and incidentally I
would do far better percentage wise if I were working with
small sums — there are just way more opportunities. If
you're working with a small sum you have thousands and
thousands of potential opportunities and when we work
with large sums, we just — we have relatively few
possibilities in the investment world which can make a real

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