Buffettology

Warren Buffett's Investing Techniques

Mary Buffett, David Clark

• Publisher: Simon & Schuster UK
• Year: 2012
• Print ISBN: 9780671032487
• eBook ISBN: 9781471104459
• Topic: Business
• Subtopic: Business General
• Index: Business

At last, here is a book that reveals what the public really wants to know about this legendary investor: how he determines where he puts his money. From a team with privileged insight, Mary Buffett, a savvy CEO and Warren Buffett's former daughter-in-law, and David Clarke, a successful portfolio analyst, comes BUFFETTOLOGY, the most detailed explanation ever of the billionaire's unique investment techniques. Using Warren Buffett's system to access a company's potential economic excellence and the right price to pay for its stock, BUFFETTOLOGY demonstrates the actual mathematical models and equations, revolving around three variables: the yearly per share earnings figure, its predictability, and the market price of security. With BUFFETTOLOGY, individual investors will come to truly understand, and emulate, Warren Buffett's masterful insight, and see that investment is most intelligent when it is most businesslike.

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PART I

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The Art of Basic Buffettology

1

Before You Begin This Book

This book is not another cut-and-paste of Warren Buffett’s letters to Berkshire Hathaway shareholders, nor is it a biography filled with anecdotes about Buffett. It is, instead, the most comprehensive case study and detailed explanation ever written on Buffett’s investment techniques.

The book is designed to teach you Buffett’s extraordinarily successful system of business perspective investing, from the concepts and mathematical equations that assist him in making his investment decisions to the actual companies that have captured his interest.

Warren Buffett did not participate in the writing of this book, and I am sure he never envisioned that, of all people, his former daughter-in-law would write such a book. During the 1970s, I was a businesswoman working in the management of a music publishing company and the operation of a successful import-export business. But in 1981, after a very romantic courtship, I married Warren Buffett’s son Peter and found myself a member of one of the world’s wealthiest families.

F. Scott Fitzgerald wrote that the very rich are different from you and me. He was right. But they are different in the strangest of ways, the oddest being the code of silence that they demand of family and friends. While married to Peter, I was instructed more than once not to speak to anyone outside the family about Warren and his investment operations. Writing this book simply would have been out of the question.

But in 1993 Peter and I were divorced, which shattered my heart into a thousand tears. Shortly thereafter, I was set upon by a flock of hopeful literary agents, all beckoning me to write an exposé about Warren Buffett and his family. Very little had been written about Warren’s personal life, and the deals I was offered, I admit, given my postdivorce state of mind, were very enticing. In the end I rejected them all.

I felt at the time, and still do, that people are really, truly interested only in learning how Warren, by investing in the stock market, turned an initial $105,000 into a $20 billion-plus fortune. I always found that aspect of Warren to be completely fascinating, which is why I wrote this book and not the other.

After deciding to undertake this project, I got in touch with David Clark, an investment analyst and longtime Buffett family friend in Omaha, whom I had met at Warren’s home sixteen years ago. David once suggested to Peter that he write a book on his father’s investment methods. (I know that many people assume Warren’s children have little or no understanding of what their father does. This is not true. From the time the children were born, and throughout their teenage years, Warren ran part of his investment operations out of a small study in the family home. Though his oldest son, Howard, and his middle daughter, Susie, are probably better versed than Peter, all of them have an excellent grasp of how their father works his investment magic.)

I asked David if he would be interested in helping with a book on Warren’s business perspective investment philosophy. David is considered by many in- and outside the Buffett camp to be one of the most gifted young Buffettologists practicing today. He is also something of a financial historian. Though I felt competent to present accurately the qualitative side of Warren’s method of business perspective investing, I knew that I needed someone of David’s caliber to fully explain the quantitative side. To my luck, David consented and soon became a major proponent in making this book the definitive work on Warren’s investment methods.

Warren’s interest in teaching his philosophy to his family ebbed and flowed. In the early years of my marriage, Warren celebrated Christmas morning by tossing out to each of his children and their spouses envelopes with a gift of $10,000. Like a jolly billionaire version of old Saint Nicholas, he would fling the envelopes across the living room, laughing “Merry Christmas” to each of the delighted recipients. Later he decided that we should be taking a stronger interest in the family business and replaced the $10,000 with $10,000 worth of stock in a business in which he had recently invested. The stock of Capital Cities, Americus Trust for Coca-Cola (a publicly traded trust, no longer in existence, that held Coca-Cola stock), Freddie Mac, and Service Master were some of the great companies I found in my Christmas stocking.

It didn’t take long to figure out that as bountiful as Christmas was, it was even more profitable to add to our newly acquired stock positions. Without fail, these Christmas gifts would dramatically increase in value. They truly were the gifts that kept on giving. Eventually we began to refer to these gifts as the Christmas stock tip, with both stock and tip eagerly awaited as the holidays drew near.

But they were more than just Christmas gifts or stock tips. They were Warren’s way of getting us to pay attention to the companies that these stocks represented. Walter Schloss, a great investor and longtime friend of Warren’s, once said that you never really know a company until you own part of it. He was absolutely right. With each Christmas gift, annual reports and dividend checks would start appearing in the mail. The Wall Street Journal became a household fixture, and we all began carefully tracking our newly acquired interests in these wonderful businesses.

I realized Warren had little use for typical Wall Street banter. He didn’t seem to care which way the Dow Jones Industrial Average went, and he certainly had no use for all the soothsayers and their predictions. In fact, he acted as if the entire stock market didn’t exist. He never looked at a chart, and if anyone tried to give him a stock tip he would usually shut him or her off. He took particular delight in attacking the Efficient Market Theory, which he thought was absolute rubbish. He seemed to care only about the individual businesses he was interested in owning. He is an intensely focused individual.

As any good Buffettologist would, I began reading the old Berkshire Hathaway annual reports and Warren’s original letters to his limited partners, all of which were fascinating. I was also fortunate to be on hand the few times that Warren lectured to graduate business students at Stanford University. Peter and I would sit in the back of the room with a video camera, recording Dad for posterity.

Eventually I perused copies of Benjamin Graham’s two books, The Intelligent Investor and Security Analysis. As informative and insightful as Graham’s books are, it seemed that his writings were very distant from where Warren now was. It was Graham who developed the concept of business perspective investing, which is the cornerstone of Warren’s philosophy.

It was around this time that Warren began showing an interest in teaching the grandchildren. I’ll always remember the day I discovered our eight-year-old twin girls curled up on the living room sofa with the Wall Street Journal spread out before them. They had just returned from visiting Grandpa’s home in Omaha, and I couldn’t help but be amused at what I found. Jokingly, I asked if they had any investment ideas. They looked up and replied, “Pillsbury,” and then rattled off a list of consumer monopolies that Warren had taught them Pillsbury owned. The most fascinating to them were Burger King and Häagen-Dazs ice cream. As Warren says, invest in companies that make products you understand. (Pillsbury was bought out a few years later by Grand Metropolitan at about double the price it was trading at when the twins made their recommendation.)

I started to see Warren as a sort of collector. Instead of collecting expensive paintings, palatial mansions, million-dollar yachts, or the other clutter with which many superrich fill their lives, he collects excellent businesses. He has spent the majority of his life searching out a particular kind of business in which to invest. He calls it a consumer monopoly. It is a business entity that we’ll discuss later on in great detail.

I noticed that Warren, like any sophisticated collector, was very careful about the price he was willing to pay for one of these trophy businesses. In fact, the price for the business absolutely determined whether he would buy it. I am not talking about whether he could afford it. That is a given. He was simply looking for the right deal. I discovered that Warren first identifies what he wants to buy and then lets the price of the security determine whether it should be bought.

These are two distinct thoughts: What to buy? At what price? That’s what this book is about—how Warren determines what companies he wants to invest in and what price he is willing to pay. Sounds simple, doesn’t it? It is and it isn’t.

If you are at all interested in investing, I think that you are going to find this book immensely fascinating and very profitable. David and I wrote it in a manner that allows the reader to progress through the key concepts before diving into the more detailed stuff. The first half is the qualitative side of the equation. It covers the general theories for determining what sort of companies you should be interested in. The second half is the quantitative portion, and it is loaded with math. That’s where you’ll learn how to determine the right price to pay. Both parts are key to your understanding of Warren’s investment philosophy. We think that you will find this book a complete revelation, for we cover an immense amount of never-before-seen material.

We have given you a list of fifty-four companies in which Warren has invested in the past and in which we believe he is still interested. Most of these companies are being identified as Buffett companies for the first time. But one word of caution. Don’t fall into the trap of thinking that just because Warren might be interested in owning more of a certain company, you should buy it at any price. We will show you how to determine the right price. Please be patient.

We have incorporated into the book the use of a Texas Instruments BA-35 Solar financial calculator. Twenty-five years ago these little wonders didn’t exist, but thanks to the brilliance of Texas Instruments, a world that once belonged only to Wall Street analysts is now accessible and understandable to anyone.

When planning the layout of the book we wanted it to be accessible to people who read on the run—in airports, on commuter trains, while waiting to pick up the children from school, or in that hour or so one has after the rest of the family has gone to bed. And so, the chapters have intentionally been kept short and focused. We also incorporate a teaching technique of reiterating key concepts throughout. So if you set the book down for a week or two, don’t be afraid to pick it up and start reading where you left off.

I look to the future and see you truly understanding Warren Buffett’s masterful manifestation of Benjamin Graham’s brilliant insight: investment is most intelligent when it is most businesslike. In the process you will become, like Warren, an intelligent investor.

MARY BUFFETT
Los Angeles, 1997

2

How to Use This Book

Folly and discipline are the key elements of Warren Buffett’s philosophy of investing—other people’s follies and Warren’s discipline. Warren commits capital to investment only when it makes sense from a business perspective. It is business perspective investing that gives him the discipline to exploit the stock market’s folly. Business perspective investing is the theme of this book.

This discipline of investing from a business perspective has made Warren the second richest business person in the world. Currently Warren’s net worth is in excess of $20 billion. Warren is the only billionaire who has made it to the Forbes list of the four hundred richest Americans solely by investing in the stock market. Over the last thirty-two years his investment portfolio has produced an average annual compounding rate of return of 23.8%.

As humans we are susceptible to the herd mentality, and so we often fall victim to the emotional vicissitudes that propel the stock market and feed enormous profits to those who are disciplined, like Warren. When the Dow Jones Industrial Average has just dropped 508 points and all the sheep are jumping ship, it is investing from a business perspective that gives Warren the confidence to step into that pit of fear and greed we call the stock market and start buying. When the stock market soars to the stratosphere, it is the discipline of investing from a business perspective that keeps Warren from foolishly allocating capital to business ventures that have neither hope nor prospects of giving him a decent return on his investment.

This book is about the discipline of investing only from a business perspective. Together we will explore the origin and evolution of this philosophy. We will delve into the early writings of Warren’s mentor Benjamin Graham and the ideas of other financial luminaries of this century, and travel to the present to explore the substance of Warren’s philosophy.

Warren made his fortune investing in the securities of many different types of businesses. His preference is to acquire 100% ownership of an enterprise that has excellent business economics and management. When he is unable to do that, his next choice is to make a long-term minority investment in the common stock of a company that also has excellent business economics and management. What confuses people who are trying to decipher his philosophy is that he also makes investments in long-, medium-, and short-term income securities. And he is a big player in the field of arbitrage.

The characteristics of the businesses that he is investing in will vary according to the nature of his investment. A company that he is willing to invest in for arbitrage purposes may not be the kind of business in which he wants to make a long-term investment. But regardless of the type of business or the nature of the investment, Warren always uses the basics of business perspective investing as the foundation for his decision.

Most people have the intellectual capacity to understand Warren’s philosophy of investing from a business perspective, but few have the dedication and willingness to work to learn the tools of his craft. The purpose of this book is to lay out, step by step, the foundation of Warren’s philosophy and the manner in which he applies it. This book is a tool to facilitate the task of learning, and it is our intention to teach you Warren’s philosophy so that you may acquire the skills to practice this discipline yourself.

Before we start, I would like to introduce a few concepts and terms that will be used throughout the book and give you an idea of where we will be heading as we voyage through the seas of high finance.

First of all, let’s take the term “intrinsic value.” Its definition has been debated for the last hundred years. It fits into our scheme because Warren will ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Dedication
• ACKNOWLEDGMENTS
• CONTENTS
• DISCLAIMER
• PART I: The Art of Basic Buffettology
• PART II: Advanced Buffettology