Wednesday, December 7, 2011 26 comments

Warren Buffett's Evolution and his Three Investment Styles

A Young Warren Buffett

In a comment to one of my posts, Mark Carter, who incidentally appears to have a good blog worth checking out, asked:

"Buffett Prime is 1970's to early 1990's"

Could you elaborate?

I have vaguely indicated how I view Warren Buffett in the past, but I thought I would detail my view of his investing behaviour. This is more of an opinion piece and many others would disagree with me (if you do, I'm curious to hear your thoughts). I don't follow Warren Buffett as closely as many value investors so I may get some facts wrong.

My view is that Warren Buffett went through three different phases, with each consisting of different investment techniques. The overall investment theory remained the same—what people call value investing—but his execution, tactics, and strategy differs across the three phases. Some people may break up his career into additional periods but my feeling is that the three I will describe essentially captures the styles.

I should also mention that I'm painting with a broad brush and some elements overlap across periods. Furthermore, certain investment techniques, such as special situation investing (such as risk arbitrage), has been carried out by Buffett over his entire life; what I am describing is his core investment technique.



Phase I: Classic Value Investor

In percentage terms (and hence, in terms of "skill"), Warren Buffett had his strongest return during his early days when he ran a hedge fund. He posted 13 years in a row with no loss and significant outperformance during the 1950's and 1960's (data below from The Superinvestors of Graham-and-Doddsville).


As you can see, Warren Buffett posted no losses, even when S&P 500 was down; and returned 23.8% for limited partners versus DJIA's annual return of 7.4%.

During the early days, Warren Buffett was essentially what I call a classic value investor. By this, I mean anyone who closely follows the Benjamin-Graham-style investing. Namely, this type of investing has the following characteristics in my opinion:
  • Focuses heavily on the balance sheet (as opposed to the income statement or earnings power)
  • Attempts to buy assets way below intrinsic value (usually 33% to 50% below what one thinks is the intrinsic value)
  • Strategy typically involves selling the asset if it approaches or surpasses the intrinsic value (this contrasts with other approaches, described below, where you buy & hold "forever")
  • Generally involves high diversification (although Warren Buffett didn't diversify very much)
  • Because good companies rarely trade way below intrinsic value, followers of this strategy, including Warren Buffett, often buy secondary/weak companies or smallcaps/microcaps (note: this was not the case during, say, the 1930's to 1940's when high quality, lagecaps actually traded way below intrinsic value)
For, perhaps, the first 20 years of his investing life, Warren Buffett was a classic value investor (on top of dabbling in risk arbitrage and the like). Buffett generally bought companies trading way below intrinsic value (usually at 2/3 or 1/2 of their intrinsic value) and then sold them when price rose to intrinsic value.

Warren Buffett didn't diversify very much but many classic value investors diversify a lot because many of the firms they buy are dubious businesses. Even if a few blow up, you'll be fine if you have numerous holdings. If you buy a company trading at 50% of intrinsic value, and you sell it in 5 years when it reaches 100% of intrinsic value, you will earn a little under 20% per year (i.e. investment will double in 5 years).

Successful classic value investors are Benjamin Graham, Walter Schloss, Martin Whitman*, and Seth Klarman.

(* I would say that Martin Whitman is mostly a classic value investor; however, a lot of his work involves tactics that resemble special situation investing such as restructurings or risk arbitrage).

Phase II: Buffett Prime

I have to do some research to pin down the exact years but, roughly speaking, the second phase of Buffett's career spanned the 1970's, up to early 1990's. This is the phase I call Buffett Prime.

Although Warren Buffett had stronger percentage returns in phase I, I would say he created way more wealth in dollar terms, during phase II. The first phase made Warren Buffett a millionaire but the Buffett Prime stage is what put Buffett on the map. This is the phase when Warren Buffett bought large, dominant, companies like Washington Post, American Express, and Geico.

Warren Buffett used to be 100% Benjamin Graham during phase I, whereas he started being influenced by Philip Fisher and Charlie Munger during the 1970's (and early 60's to some degree). Fisher and Munger instilled growth investing into Warren Buffett. Whereas Graham had a singular focus on the strength of the balance sheet and quantitative factors, Fisher/Munger taught Warren Buffett to look at earnings power and qualitative elements. Warren Buffett started to realize, and put into practice, the notion that earnings power and qualitative factors (such as brands or intellectual property) gel to form a powerful moat. The notion of a moat may have been used in earlier times but it really became powerful when you focus on earnings power and hard-to-measure qualitative elements.

Buffett also started buying companies, not way-below intrinsic value, but close to intrinsic value. Instead of buying weak companies that are significantly undervalued, he started buying great companies at fair or slightly-below-fair-value prices. If you were able to get a great company for a fairly reasonable, albeit not extremely cheap, price, it also meant that you could hold on to them for a long period of time. Great companies have long lifespans and high return on equity so it didn't make sense to sell these golden geese just because they hit intrinsic value.

Since the Buffett-Prime style interests me, I could write a lot on this topic and may do so in the future. So I'm not going to go into a whole lot of detail here.

In my opinion, Warren Buffett's greatest period was his Buffett Prime period. There are very few investments in the history books that resemble some of his spectacular buys during this phase. His top investment of all time is Geico but his second-best may be Washington Post (or See's Candies too), whose chart is shown below:


You could see the skill of Warren Buffett with this chart. The stock went up 16,000% in around 35 years (without even including dividends). Not just that, but it was a concentrated bet! Some people will end up with multi-baggers but they are never concentrated positions so their overall returns aren't spectacular. That isn't the case with Warren Buffett.

Although his star has dimmed, I would say Edward Lampert is an example of a Buffett-Prime-type investor. Charlie Munger is also a good example of a Buffett-Prime-type investor. There may be other sucessful investors in the hedge fund world but I am not familiar with anyone else in the public investing world.


Phase III: Modern Buffett

What most young investors, as well as newbies and the media, are familiar with is Warren Buffett's recent investment style. I term this period, stretching from the 90's to the present, Modern Buffett.

Warren Buffett started facing a problem in the 90's that only successful investors do. When you are successful, what happens is that your portfolio gets very large. Unlike many other activities in life, investment returns grow exponentially—that's why a continuous 1% gap makes a huge difference over the long run, and it's also why there is a huge gap between the successful and the rest—so you will end up with very large portfolios if you are successful. You see numerous hedge funds, mutual funds, and pension funds with large portfolios but that is largely due to investors adding capital. In the case of Buffett, his company grew organically without capital injections, and since it didn't return any money to shareholders through dividends or share buyback (except very recently), it grew very large.

On top of having an existing portfolio that is large, since Berkshire Hathaway and its stock investments are so good, they generate literally $1 billion every month that needs to be deployed (or returned to shareholders—historically Berkshire Hathaway didn't return money to shareholders).
When you become very large, your investment opportunities are few and far between. Warren Buffett's problems were:
  • He needs to deploy large amounts of capital so he has to consider large companies, say more than $1 billion in size (otherwise you will be spending all your time searching for companies and have to buy hundreads of them every year—not an easy task for a concentrated stockpicker)
  • He needs to find companies in his circle of competence (not only do you have to find large companies but you need to understand them)
  • He needs to buy them at attractive valuations (even if you find a large company in your circle of competence, you need to buy them when they are cheap)
Needless to say, the issues cited above have radically changed Warren Buffett over the last two decades. He has had to adjust his investment strategy and accept lower returns. His Modern Buffett investing resembles institutional investing rather than the pure stockpicking he used to do so well.

In particular, I think the Modern Buffett strategy is different from the prior two phases as follows:
  • Focus on largecaps and megacaps: Except for select family businesses that are bought outright, Buffett almost exclusively buys large companies.
  • Purchase of capital-intensive businesses: Since large amounts of capital need to be deployed, Warren Buffett has started buying capital-intensive businesses like utilities and railroads. He never would have purchased these in earlier phases (unless if they were extremely cheap).
  • Pursuit of foreign companies: This isn't a strategic element per se but Buffett does look at foreign companies more so than in the past.
  • Acceptance of lower ROI as well as businesses with lower return on equity: Whereas he was aiming for (probably) companies with 15% to 20% ROE (with ROI target of 15%) in the past, he is now ok with firms that yield ROEs of around 10% (with a target ROI of around 12% or maybe 1% to 2% better than S&P 500).
  • Capital injections: Although not a core strategy per se, I notice that Buffett is more willing to inject emergency capital into companies that he doesn't have any long-term interest in. For example, he injected capital into companies like Tiffany, Harley Davidson, Goldman Sachs, GE, and Bank of America in the last 4 years but I doubt he really wants to own any of them for the long run.
I'm sure I'm missing a few other items but those are the thoughts that come to mind right now.

Overall, Modern Buffett is very different than Buffett Prime. Although Buffett is still a value investor and follows the same philosophy as always, the details are different. For instance, I honestly don't think the classic-investor-Buffett or the Buffett-Prime-Buffett would have purchased a capital-intensive low-return railroad like Burlington Northern Santa Fe. The former wouldn't have purchased BNSF because the price wasn't cheap; the latter would have skipped it because the underlying business characteristics aren't good.

The Modern Buffett's returns have deteriorated from the past:

Although still impressive and better than what most will ever earn in their lives, Warren Buffett's returns, as measured by Berkshire Hathaway book value growth, hasn't been that great in the current phase.

As for examples of good Modern Buffett investors, I am not entirely sure. There aren't too many investors with the too-much-money problem. Many who appear to be successful and end up with a large capital base often blow up badly and never really get into the Modern Buffett phase (investors like Bill Miller and Bruce Berkowitz come to mind.)

Final Thoughts

My opinion, which others may dispute, is that Warren Buffett has gone through three phases. Each phase is significantly different, even though they all folow the value investing theory and framework. The classic value investing style is value-oriented; while the Buffett Prime style is growth-oriented; and the Modern Buffett style is institutional-investing-oriented.

If you are a newbie value investor, I would recommend that you choose the classic value investor style or the Buffett Prime style as your goal (assuming you are influenced by Buffett). I wouldn't recommend the Modern Buffett unless you had little time to pursue investing, can't handle too much risk and/or don't want to put in the effort.

Having said that, my impression is that the vast majority of so-called amateur value investors you see on message boards and the like are pursuing the Modern Buffett style. Another mistake I notice is that some amateurs pretend to be Buffett Prime investors but never do the due diligence or can ever explain the business model of the company.

I personally am aiming to be more of a Buffett Prime investor. I'm not a true value investor—I'm macro-oriented and that conflicts with value principles—but I hope to be as close to Buffett Prime as possible. This choice isn't because Buffett Prime is necessarily better; instead, it is just something that suits me. Some of you may be more suited to be classic value investors, especially if you like focusing on the balance sheet and thinking about asset values.


I haven't written many original articles this year—neither have I done any investing :(—but hope you enjoyed this blog post. Good luck with your investing!

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26 Response to Warren Buffett's Evolution and his Three Investment Styles

Anonymous
December 8, 2011 at 6:41 AM

I'd like to ask a couple of follow-up questions.

In Buffett Phase I, do you think his success is down to unique business insight (I assume not), spotting obscure anomolies, or was it just a case of flipping through Value Line and trying to eye up the net-nets?

In Buffett Pase II, I hear that he bought Washington Post when it was valued at $100m, where "everybody knew" it was worth $400m. I would like to see some justification of that valution.

December 8, 2011 at 7:37 AM

Great post, and I think you are definately on to something. Your argument, that most small retail investors believe they are following Buffett will be disappointed that they do not get anything like his results. He did not get to be "Warren Buffet" from buying large cap liquid stocks. He got there buying illiquid small stocks, taking control of a business, to provide investment capital (float) and by making the most of some favorable market conditions.

Buffett has changed his style, both in response to his situation (the amount of capital he has to deploy) and also in response to the investing environment he faces.

Buffett I was incredibly successful, in part because he was able to focus on obscure companies and acquire them at incredible prices. If you read (in The Snowball) about Buffett sending people out with cash to collect the stock certificates of Blue Chip Stamps you realise that his early success was not based on stock picking in the marketplace, it was based on the ability to spot what he wanted (in this case investment float) and make a market in it.

Buffett I coincided with a big economic and stock market boom, particularly after 1954. However, not unlike in the 1990s, the boom became increasingly concentrated. Buffett avoided the trap by looking elsewhere, so his results deviated significantly from the market.

December 8, 2011 at 7:38 AM

Buffett II, as you rightly point out, was his "coming out" - when he began to invest and take major stakes in publicly traded companies. This had the disadvantage of leaving Buffett without full ownership, and had the blessing and the curse of enabling lots of people to see and measure the performance of his individual investments.

He changed his investment style at this point to one of buy and hold ("forever") because he could no longer sell quietly. People knew who he was, and knew if he was selling, they probably didn't want to be buying. Moreover, he had to declare his activities almost immediately because he owned significant stakes in publicly traded companies. If he moved a portion of a position, others could easily front run him as he sought to eliminate the position.

Given the inherent drawbacks in these investments (unexitable positions, public scrutiny and the like), one might be surprised he didn't stay with his small, private firm focus.

One reason he changed was that as a result of strong results he had lots more capital to deploy.

But another reason he moved to purchasing shares of large, publicly traded companies is that they were just so darn cheap in the 1970s. Macro factors, including recession and inflation meant that unlike in the 1960s, large caps were on sale.

Of course, he made some spectacular buys, like WaPo, so again, his results were remarkable.

As the 1980s became the 1990s, the fact was that the market became, like the 1960s, dominated by a few large companies. As you say, Buffett could no longer invest in small caps, and almost no business was trading at a discount to book value, unless it was truly distressed, which is not Buffett's style. So he went back to focusing on growing his insurance operations and finding large, owner-controlled businesses looking for a home.

This was a true breakthrough for him, because, again he made a virtue of necessity. Since he essentially cannot sell (no one would buy at a price he would consider fair), he has made his firm a parking lot for great businesses, on the promise that he will not break them up and sell off the pieces. This is very appealing to family owners who also want to have a liquidity event without losing the company.

But of course, these sorts of investments are rare and the economics are not as favorable as they have been in the past.

Just don't forget, he made his money when stocks were cheap. Since they have been expensive since about 1994 (with a brief interlude of favorable valuation from October 2008 to April 2009), returns are likely to be less good, because he simply cannot deploy the capital at the compounding rates available 30 years ago. Sadly, all investors face this problem, unless they are taking massive ideosyncratic (i.e. single company) risk.

December 8, 2011 at 7:46 AM

To the anonymous comment poster -

Buffett did indeed spot "anomalies". Not the kind traders are looking at, but cases where prices looked severely out of whack with the company's assets. He found them primarily in small stocks that were unloved and largely ignored.

He actually "made a market" in over the counter stocks he was interested in using some very aggressive sales techniques. This is how he acquired Blue Chip Stamps and with it National Indemnity, the true core of what has become Berkshire.

He found these things because he looked at them differently. While most people were looking at earnings power and dividends, Buffett was looking at assets and capital. He knew that if he could get his hands on cheap "float" he could accelerate his returns by deploying the capital more effectively than the previous management. Note, though, that this strategy only works if you are in a position to control the company. Most of the investors were passive, and looking for distributions, thus, the companies were worth less than book value, since the assets could not produce strong earnings to distribute.

Regarding the WaPo deal, the stock was trading at a market valuation between $85 and $100mn when he purchased in 1973. This was due in no small part to the deep bear market that was taking down all stocks indescriminantly.

The $400mn figure comes from Buffett himself, who, having analyzed the company put that estimate of intrinsic value on the stock. With such an incredible margin of safety on such an incredible asset, Buffett wanted to buy the entire business but was thwarted by the Graham family which wawnted to maintain control.

He agreed to take no more than 15% ownership, an $11mn purchase that is now worth $1.5bn, and that is before dividends which annually exceed the entire amount of his purchase price.

December 8, 2011 at 7:51 AM

Final thought for the day.

In my opinion, a good current example of a Phase I "Buffett Stock" is Bassett furniture (BSET). This is a company that has a marginally profitable furniture company (undergoing constant restructuring) and a transition from manufacturing to retail (maintaining design). But the assets the company has are remarkable. It had huge investments in Hedge Funds and Real Estate, and has liquidated most of those, and now trades at a slight premium to net cash, valuing the furniture business at zero.

As long as Bassett operates it, that might be an appropriate valuation (though the numbers are getting less bad). Fact is, the company still holds some good real estate in Virginia and elsewhere, and the Bassett name itself has a value of several dollars per share, which means that the stock trades for less than liquidation value (would that management would see this....)

Full disclosure, I own shares.

But sadly, I won't have Buffett like results, because I cannot force management to liquidate the furniture company and use the money to buy businesses with better economics and prospects.

Probably this means that I should sell, because buying Buffett I companies without Buffett I strategy (take control) is probably a recipie for bad investment returns.

Anonymous
December 8, 2011 at 11:47 AM

Nice Post.

I greatly appreciate the work you've done with the data demonstrating how his tactics and strategies changed over time.

What you've said here has been said by Seth Klarman in an interview some time ago ( buffet started with cigar butts, moved to great businesses at reasonable prices and to good businesses at fair prices, while klarman's mostly concentrating on cigar butts)

The way Buffet prime worked has quite layer of financial engineering aspect underlying the value investing aspect to it. Just to Illustrate, If you own an insurance company the float i.e money left after maintaining reserves for claims 10% (assumption), and cost of the insurance to be paid contingent on claims on a $ 100 is 9% ( assumption) you've got $90 to invest and as business grows you'll have a recurring $90 (premiums collected) and even after claims paid at 9-20% of float. If he earns anything above the required 10% ( 10% on $90 is 9% on $100) it's his company's capital. If you read about buffet you would understand that he made profit on insurance as well as the float where as most insurance companies lose on insurance and make money on float. Very few like Lloyds of London has profits on Insurance.

About diversification Graham in "Intelligent investor" specifically says to diversify but not to over diversify and his own conduct shows that he held some where up to 15 investments and not more than that and many value investors still follow the same.( most of them tend to hold about 10 investments at a time Ex: Greenblatt, Pabrai, Klarman,Schloss,heine,price)
One thing to remember though is that he'd had draw downs of 50 % a couple of times and draw downs of 30% a few times which in today's hedge fund structure might leave him high and dry and that's where his structure as a company gives him very long term capital that will not affect his strategy even when his investors are spooked. (ex 2008). There were many illusions on why he's successful, though many value managers did achieve those returns, his structure gave him an inherent advantage over todays hedge fund managers and Walter schloss as he's worked with graham even before buffet joined graham and newman partnership. Even though buffet offered graham that he'd work for free he was turned down while schloss was a paid employee.

December 8, 2011 at 4:43 PM

Good write-up. Some of his moves in the current phase require questions: BAC, Lubizol, IBM.

December 8, 2011 at 8:42 PM

Thanks for the comments everyone. I'm going to try responding to all but not necessarily in the same order.

Anonymous: "The way Buffet prime worked has quite layer of financial engineering aspect underlying the value investing aspect to it."

Yes, you are quite correct in pointing out how Warren Buffett leveraged the float from his insurance to boost returns. However, you still have to be a very good investor to do this or else everyone would be doing it. Do keep in mind that you have to be a really good investor to succeed. If you lose money or face medium-term declines in asset values, your insurance float borrowing will cause problems if the float needs to be paid out for insurance claims.

The use of insurance float for leverage is one way Warren Buffett continued to outperform hedge funds, who typically have sizeable leverage.

Anon: "One thing to remember though is that he'd had draw downs of 50 % a couple of times and draw downs of 30% a few times which in today's hedge fund structure might leave him high and dry and that's where his structure as a company gives him very long term capital that will not affect his strategy even when his investors are spooked. (ex 2008). "

I think the drawdown problem you cite is very real if you are managing money. But I think Buffett would have faced the same problem in the past. The key difference is that he gained the trust of his investors. Through hard work and skill, he managed to get the right type of investors for his hedge fund, as well as the public Berkshire Hathaway. If you are a fund manager, it is critical that you have the right type of investors. Value investors and contrarian investors really need long-term investors that can tolerate drawdowns. Not easy to find these investors..

December 8, 2011 at 8:54 PM

Doug,

Good responses. I just checked out your blog and I think you should post your responses here on your blog (if you haven't written about them before). It preserves your comments and you may want to expand on them in the future.

Here are my thoughts on a few points you made...

Doug:He did not get to be "Warren Buffet" from buying large cap liquid stocks.


Yep. That's probably mistake #1 for many Buffett-wannabe investors. Unless you can identify select companies, possibly during a crisis or stock market crash, you just aren't going to to get rich buying Coca-Cola, Johnson & Johnson, or P&G.

Doug: He got there buying illiquid small stocks, taking control of a business, to provide investment capital (float) and by making the most of some favorable market conditions


I don't agree entirely with this statement. I don't think you need to go for microcaps or smallcaps. Although the chance of such stocks being mispriced, and hence yield higher returns, is higher, they are way more dangerous and it's not clear to me they are the ideal sweet spot.

The difficulty for amateur investors is that, although the valuation part is probably easier with small, illiquid, stocks (since they are usually cheap), I think one is more prone to making big mistakes about the underlying business characteristics (such as what the business model is, its competitive strength, corporate governance, etc).

I have a horrible investing record but my preference--I'm more of a Buffett Prime investor though--is for mid-caps to (distressed) large-caps. I think companies worth around $1 billion to $5 billion are probably the ideal (at least in big markets like America or Canada).

As for the control part, that's a good point and I like to always say that amateur investors should always assume they are, as Martin Whitman says, OPMI - outside, passive, minority investor. Unless you become successful or run a large fund, we are never going to have much control or influence over management. This limitation definitely diferentiates us from Warren Buffett, who was always more of a control investor.

Sivaram Velauthapillai
December 8, 2011 at 9:10 PM

Doug: "He changed his investment style at this point to one of buy and hold ("forever") because he could no longer sell quietly."


The reasons you cited for pursuing a Buffett-Prime-style investing are correct. However, there is one major reason Buffett Prime is actually better.

One of the things about buying a great business with high ROE is that it internally compounds its returns at a high rate. I forget the exact number but I think Munger said something like 6(?) investments account for 70% of Berkshire Hathaway's lifetime returns.

Instead of continuously searching for investments, under the classic value investing style, Buffett realized that buying a few good companies meant that you could hold on to them forever.

On top of my lack of interest with asset-oriented investments, one of the reasons I am pursuing Buffett-Prime-type investing is because you don't need to buy too many things. A lifetime with a 20 punchcard, as Buffett has alluded to, is more than enough.

I would rather spend my time searching for the perfect investment and bet big on that. And hold it forever! This is what Buffett capitalized on in his second phase.


Doug: "In my opinion, a good current example of a Phase I "Buffett Stock" is Bassett furniture (BSET). "

I'll take a look at that at some point. I don't like microcaps (poor corporate governance, hard to unlock value, losing money, etc) but that looks interesting.

I don't know if you encountered Geoff Gannon, but he is an amateur investor who is very-classic-value and seems similar to your investing:

http://www.gannononinvesting.com/

December 8, 2011 at 9:30 PM

FIRST ANONYMOUS: "In Buffett Phase I, do you think his success is down to unique business insight (I assume not), spotting obscure anomolies, or was it just a case of flipping through Value Line and trying to eye up the net-nets?"

You need all three--and more. What do I mean by that?

Warren Buffett worked really hard to find investment opportunities. He flipped through stock journals, read newspapers, talked to people on the street, etc. Everyone needs some means of searching for opportunities.

The key is to spot the mispricing. This is absolutely key! If you can't spot a mispriced asset--and the market is efficient most of the time!--you just won't make any money.

Once you find what looks like a mispriced asset, you need to evaluate its risk and understand the underlying business. Warren Buffett, like all good investors, definitely developed insight into different industries. His circle of competence was initially small but it grew over time. I would say Warren Buffett's industry expertise is in insurance (and financials to some degree), consumer goods (consumer packaged goods, consumer staples), media/advertising, and old industrials. There are areas where Warren Buffett doesn't have much industry expertise (such as technology and healthcare).

So, to answer you question, you kind of need to do all three. But they are not exactly overlapping activities. Once you get the hang of things, you'll do all three, often almost simultaneously.

Warren Buffett's success came down to his intrinsic abilities and talent (no one else has it--just like you or I aren't like Jordan or Gretzky); and his hard work and focus on the elements you have described above. No one is going to be like Buffett but if you are even 1/3 of him, you'll be really successful.


FIRST ANONYMOUS: "In Buffett Pase II, I hear that he bought Washington Post when it was valued at $100m, where "everybody knew" it was worth $400m. I would like to see some justification of that valution"

I haven't looked up the details but it doesn't surprise me. Here is the story for those not familiar.

The story shouldn't be that surprising. Wall Street always turns bearish if the short-term outlook is bad.I can't think of a good example right now.

Based on the Buffett quote linked above, I think the situation was one where the market value was $80 million but sum of parts valuation was $400 million.

I don't think it was a case of Wall Street saying the company was worth $400m but we are going to price it as if it was only $80m. Instead, I think someone had to do the sum of the parts valuation.

December 9, 2011 at 3:03 AM

Sivaram

Thanks for all the feedback. The companies that made Buffett rich (though not famous) were Berkshire (huge tax loss shelters) with a market cap of less than $20mn, Blue Chip Stamps (undervalued float), same price level, and Sees Candies which he acquired for $25mn (but which has generated over $1bn of cash to Berkshire, according to Buffett). This is definately one of the six companies Munger talks about (others include Geico and WaPo).

He bought the cigar butts because they were affordable. He could get control without paying too much. He did not buy control of these companies through market stock purchases. He did it in private negotiated transactions. Small, illiquid stocks. I am not advocating this strategy for retail investors. As you point out he was not OPMI on these deals and most retail investors have neither the means nor the inclination to take control of management and capital deployment.

Your goal, which is to achieve alpha by finding mispriced stocks (greater likelihood in small and mid caps) makes sense, but recognize that the mispricing Buffett identified was the fact a better investor could earn much more with the float of a company like Blue Chip Stamps than the existing management, it is not clear if the assets were so badly pricing for OPMIs.

December 9, 2011 at 7:55 AM

One correction: doubling in 5 years is a little less than 15% annual return, not a little less than 20% as the article claims.

Strategic Investor: Tax losses need profits to shelter, so claiming they made Buffett rich is rather unfounded and, needless to say, the man himself would argue vehemently against it. Blue Chip was an OK investment at best. Actually, in his 1984 letter, he calls it ironically a "cornerstone business" that "shrunk in sales volume to about 5% its size at the time of our entry." The good that came out of Blue Chip was that it acquired See's and on this one you are totally right. By the way, this article at Monevator sheds some unconventional light over how Buffett got rich: http://monevator.com/2011/09/01/how-did-warren-buffett-get-rich/

I think the author provides a good overview of Buffett's evolution.

As for me, I marvel at the guy's focus. It really takes enormous conviction putting large, concentrated bets representing a large portion of one's net worth (or assets under management) at times when everyone is scared and/or deluded and sticking with them. And by "focus" and "conviction" I mean belief.

Believing sounds like a fanciful concept, but it is ever so hard to do, especially nowadays when there is plenty of supporting information for every possible hypothesis. Very few have Buffett's ability to look at the facts and instantly know what to do, do it, and be right.

The alternative is being constantly eaten by the worm of doubt.

December 9, 2011 at 9:08 PM

hmm... not sure why my blog seems messed up all of a sudden. Anyway...


Hi Strategic Investor,

I kind of disagree with your view, and agree with the numbered respondent (100218...), that it wasn't the tax los shelters that made Buffett rich. Losses are always bad! They don't shelter anything. For instance, you would make more money by not losing than by losing money and then using that to shelter gain elsewhere.

I don't think you give him enough credit for stockpicking. Most of his wealth did not come from private, negotiated, transactions; most came from open market purchases.

Warren Buffett was just a very good stockpicker and he learned to stay in the areas he understood. Even when he underperformed (like in the late 60's or late 90's), he didn't deviate from his strategy.

December 9, 2011 at 9:24 PM

100218307728312891730: "As for me, I marvel at the guy's focus. It really takes enormous conviction putting large, concentrated bets representing a large portion of one's net worth (or assets under management) at times when everyone is scared and/or deluded and sticking with them. And by "focus" and "conviction" I mean belief."


Yep. Buffett just sticks to his strategy even when the whole world is against him. BAck in the late 60's to early 70's period, and the late 90's to early 2000's period, he underperformed and seemed like lost his touch. But he didn't waver and stuck to his guns.

I think one reason he has conviction in his picks is because he does thorough analysis and only buys with a big margin of safety. Most newbies, including me, have no confidence in our calls because we aren't sure about intrinsic value -- and even when we are, we are impatient and don't buy with a big margin of safety.

For example, the Washington Post purchase, where he bought a $400m company for $80m shows why he could stick with his call. If you are pretty sure the company is worth around $400m and you buy it at $80m (hence a big margin of safety), you can remain confident. It's not easy to find such investments and it's hard to understand the business even if we do find such a business (for instance, many were of the view that television was going to kill newspapers back in the 70's).

December 10, 2011 at 8:50 AM

Hats off to this man, No Non-sense player in the market, plays according to the market rather than emotionally.

Anonymous
December 14, 2011 at 3:35 AM

Great post!

I liked the following:
"...some amateurs pretend to be Buffett Prime investors but never do the due diligence or can ever explain the business model of the company."

That is so true! I am tired of people pretending of being Buffet Prime just because they had 1 or 2 companies that had a good return but on average done bad and try to use different quotes to show that they are doing exactly what buffet would have done! In overall they do not know anything about the company or the industry it is operating in.

P.S.: I am more a Classic Value Investor (70%) due to the lack of time and (30% maybe less) prime or at least try to be 30% prime :)

/Andreas

December 14, 2011 at 9:12 PM

Thanks to everyone for the feedback.

ANONYMOUS (Dec 14 2011): "P.S.: I am more a Classic Value Investor (70%) due to the lack of time and (30% maybe less) prime or at least try to be 30% prime :)"


You know, I actually think that classic value investing is probably more time-consuming than the other two approaches.

The problem with classic value investing is that, although it may seem quicker to execute, especially if you use rely on some quantitative metrics, it's a strategy where you have to continuously keep searching. After you have invested in one successful asset, you'll exit it fairly quickly and then have to find another opportunity.

The beauty of the buy&hold-oriented techniques is that if you find a few good companies, you can hold them for a long time. As long as you purchased at a fairly low price, the company will compound the return on its own for a long time.

In any of the strategies you have to find the right asset at the right price. That's probably much harder with the Buffett Prime approach. A lot of the great companies are rarely ever cheap -- and even when they are, it's hard to tell whether they really are. The advantage of the Buffett Prime approach is that you only need to find 2 or 3 great investments (right company, right price) every few years.

Anonymous
December 14, 2011 at 10:22 PM

How come you didn't respond to the comment about you stealing the 'three phases' concept from a Seth Klarman interview?

December 15, 2011 at 8:15 PM

ANON: "How come you didn't respond to the comment about you stealing the 'three phases' concept from a Seth Klarman interview? "

Which interview is that? Are you talking about his latest one (this one from a few weeks ago)? If you are referring to that interview, I have to say I wasn't influenced by that, or indeed "steal" anything. I have held my three phases (or even 4 phases if you really dig deep) for a while. In fact, I have referred to 'Buffett Prime' in the past, such as this post from July 2009. I didn't hear of Klarman referring to 3 phases back in 2009 (but I don't follow Klarman closely so I wouldn't know even if he did).

In any case, my characterization of Buffett isn't the same as Klarman's three stages. Klarman doesn't go into it in that interview (and I don't know enough about Klarman to know if he has mentioned it elsewhere in the past) but I don't think my phase 2 and phase 3 are similar to Klarman's stage 2 and stage 3 (we have similar views of phase 1 though).

Again, I haven't heard Klarman elaborate his views so I'm not sure exactly what he means by the three stages but my view is that the three phases of Buffett are very different investing styles -- although all are value investing. Klarman, at least based solely on that interview, appears to look at Buffett's techniques from an asset value perspective, whereas I look at it as drastically different investing styles. For instance, I would say 'buy&hold forever' is a characteristic of phase 2 (Buffett-Prime) but under Klarman's view, it could be any stage.

For instance, if CanadianValue's phrase that Klarman's 3rd stage is " Buy great companies at so so prices" is correct, I actually don't agree with that. To me, Buffett is not buying great companies at so-so prices in phase 3. In fact I question the greatness of some of them. Instead, phase 3 is more like institutional investing, where you don't necessarily buy great companies. If you look through the top institutional funds, you'll see many holdings that don't appear great (at least to me).


Having said all that, I am not taking credit for investing the 3 phases of Buffett. In fact, I think you can even argue there are 4 phases, especially if you look deeply at Buffett's risk arbitrage/workout investments. About the only thing that may be original is my calling phase 2, Buffett Prime. I haven't heard anyone use that term before and I made that up.

The notion of 3 phases is not new. Others, including some prominent value investors, have vaguely referred to it in the past. Phase 1 and 2 are blatantly obvious and talked about frequently. But phase 3 is where people have difference of opinion.

In any case, the 3 phases of Buffett isn't from Seth Klarman. It isn't from me either. I have to refresh my memory but I think some authors have used it before, and even some prominent investors like Martin Whitman and Jean-Marie Eveillard may have used it -- not sure.

BTW, the reason I didn't respond to your accusation of stealing is because it isn't true, and it is irrelevant to the discussion.

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Anonymous
August 4, 2012 at 12:47 AM

What I don't understand is why people waste their time debating, discussing & worshiping stuff that could not better them in any way. Which of you by reading & discussing such will make a statement, will leave a mark behind? None. That's the ultimate essence of life. Leaving a sound legacy behind. Buffett has done his, so did Ford. The point now is to the same with your lives not by debating but by doing. Get busy guyes and stop lazying around!

August 4, 2012 at 1:17 PM

Debating can sharpen your knowledge and skills. That's one way people improve themselves. It's always good to see the counter-argument to your belief.

Having said that, there can be too much debate, aka debate paralysis, and at some point, people need to start acting and executing their views.

December 12, 2012 at 9:14 PM

The post about warren buffett is very interesting. The one thing about Warren Buffett that I admire most is his ability to stay steadfastly with his convictions concerning his stock selections regardless of how good or how bad the market is doing.

February 6, 2013 at 1:56 AM

Warren buffett has never braged about his record of performance. Its his fans that have bragged about warren buffetts record of performance. Do these fans not get it. I will say it once again. Warren buffett gives a lot of credit to his success in investing to the late Benjamin Graham.

April 22, 2014 at 10:49 AM

Good writeup.

My main beef is your criteria for his greatest period. I don't think that knocking the ball out of the park a few times, based on a few select investments, is what makes a great investor a great investor. I mean, it definitely shows skill -- for sure -- but being a good investor just means doing best what an investor is supposed to do best: compound money.

To me, that definitely means that his best was always pre 1969 when he was investing in investments like this:

http://www.netnethunter.com/one-hell-of-a-net-net-stock-warren-buffett-on-western-insurance-securities-company/

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