Reader Sunny's thoughts on the Warren Buffett way
Reader Sunny responded to my prior post about Geoff Gannon's thoughts on Buffett and I thought it was very insightful and worth address in a standalone post.
Before you read the following, I want to emphasize that Warren Buffett has used many different strategies throughout his life. It has ranged from risk arbitrage; classic value investing (Benjamin Graham's "cigar butts"); buy & hold forever; macro investments and speculation; and so forth. In the following discussion, we are mainly talking about the 'buy & hold forever' strategy. This generally entails buying great companies at reasonable prices and holding on to them for a long time.
Yep. Very good point! This is something that the value investing community seems to ignore or downplay for some unexplainable reason (note: I'm not talking about those following more of an old school, Graham, approach.) For instance, I rarely see anyone who appears to be making Buffett-like bets, especially on complex large-cap companies, describe the characteristics of the industry, threats, and so on. People casually mention that, this leading brand is dominant and has X% market share but never go into why. Why is it leading? What's so special about its business model? How sustainable is it? Etc.
One of my goals is to pursue more Buffett-like investments (I'm referring to buy & hold, paying up for quality companies; I pursue other strategies as well) and I have been trying to develop more skill in qualitative analysis. Due to personal problems, I have not had time to focus on investing lately but I'm planning to read more books on business strategy, industries, technology, and so on. I have started focusing more on business' moats lately. For example, when I was looking at Expedia, I was studying customer ratings (some marketing websites publish such things,) and even looked at anymous employee comments on job sites (to gauge how the culture was.) I was even tracking hotel performance—Calculated Risk regularly tracks some measures so little work involved here—because OTAs make most of their money off hotels and attractions (on a side note, it's amazing how the OTAs are doing so well, at least from a stock market point of view, while the hotels are getting killed. Tourism has fallen off a cliff during this recession but OTAs are humming along.)
I'm just a newbie with a dubious investment record so I don't know if you want to follow my advice but I think if you want to be more of a Buffett-type investor, you should read more business strategy or industry-specific books/articles/blogs/etc. If you look at the top 10 recommended books on many blogs, there are essentially zero books on strategy, brands, moats, management, industry characteristics, and so on. It may also help to read some biographies of entrepreneurs, executives, and the like.
Ideally, it would be best if all of us were also businesspeople, executives, or entrepreneurs. As you highlight from Buffett's remarks, he is a better investor because he was also a manager of several businesses. But this is not possible for most of us and, even if someone were in such a position, I don't know how many would still pursue investing (financial rewards from running the business would mean that you become an investor for personal interest/challenge rather than money.) Given our limitations, I think the best we can do is to emulate and try to be a businessperson; and conversely, a businessperson might want to think about investing. In any case, this is a serious downside to all of us who don't have exposure to both.
I don't believe the points you make in the quote above are as bad as it seems. What you are saying is true but it mainly hurts professionals. It can hurt the individual but if they can't overcome certain issues—such as being patient or willing to take quotational losses—they simply won't be value investors. I'm not trying to be arrogant or anything but such people will likely never succed with Buffett-like strategies (other strategies, such as momentum investing, may work for them.)
Very few are as patient as Buffett—sitting on the sidelines for 5 or 6 years in the late 60's—but I think most small investors can probably do it for 2 or 3 years. Professionals, on the other hand, will have a tough time. If you underperform for more than 5 or 6 quarters, your job may be at stake.
I also think the lack of time for most amateur investors isn't as bad as it seems. If you are really trying to beat the market, there probably aren't that many opportunities worth investigating. Also, let's not forget that if we keep our circle of competence somewhat small, you will have plenty of time to research opportunities.
To wrap up, I think you touched on important points every investor should think about. First and foremost, Warren Buffett doesn't just look at a company; he looks at that company within a competitive business environment. Understanding the industry and why that company appears to be more profitable is just as important as knowing how good that company is. It would help if we are both investors and businesspeople but very few of us are and that is a handicap for us. As for other traits possessed by Warren Buffett, such as patience, ability to pounce on infrequent ideas, and the like, I personally don't think that is much of an issue for amateur investors. All of us can decide on our own how much to invest, when to invest, for how long, and in what asset. No one is forcing you or I to do anything. The same cannot be said for professionals and that is a huge negative for them.
Before you read the following, I want to emphasize that Warren Buffett has used many different strategies throughout his life. It has ranged from risk arbitrage; classic value investing (Benjamin Graham's "cigar butts"); buy & hold forever; macro investments and speculation; and so forth. In the following discussion, we are mainly talking about the 'buy & hold forever' strategy. This generally entails buying great companies at reasonable prices and holding on to them for a long time.
Sunny:
Buffett - 'I am a better investor because I am a businessman and a better businessman because I am an investor'. This to me says it all. This is why Buffett is cannot be compared to other value investors and has done a lot better than others over the years.
In an interview on 60 minutes a year ago, the reporter asked him what made a good business. He described the textile business that he acquired and how the 'economics of the business' was faltering. He said the long term economics of the business has to be good for him to invest in the business. This to me gives a good insight on Buffett that most people look over. Mainly, that he does NOT rely on the backtesting methodologies and blindly invests in companies without understanding them.
From reading part of the Buffett:Snowball book, Schroder said that Buffett for example would spend hours reading about the insurance industry, understanding their models, talking with people in the industry, following market share data...etc.
Yep. Very good point! This is something that the value investing community seems to ignore or downplay for some unexplainable reason (note: I'm not talking about those following more of an old school, Graham, approach.) For instance, I rarely see anyone who appears to be making Buffett-like bets, especially on complex large-cap companies, describe the characteristics of the industry, threats, and so on. People casually mention that, this leading brand is dominant and has X% market share but never go into why. Why is it leading? What's so special about its business model? How sustainable is it? Etc.
One of my goals is to pursue more Buffett-like investments (I'm referring to buy & hold, paying up for quality companies; I pursue other strategies as well) and I have been trying to develop more skill in qualitative analysis. Due to personal problems, I have not had time to focus on investing lately but I'm planning to read more books on business strategy, industries, technology, and so on. I have started focusing more on business' moats lately. For example, when I was looking at Expedia, I was studying customer ratings (some marketing websites publish such things,) and even looked at anymous employee comments on job sites (to gauge how the culture was.) I was even tracking hotel performance—Calculated Risk regularly tracks some measures so little work involved here—because OTAs make most of their money off hotels and attractions (on a side note, it's amazing how the OTAs are doing so well, at least from a stock market point of view, while the hotels are getting killed. Tourism has fallen off a cliff during this recession but OTAs are humming along.)
I'm just a newbie with a dubious investment record so I don't know if you want to follow my advice but I think if you want to be more of a Buffett-type investor, you should read more business strategy or industry-specific books/articles/blogs/etc. If you look at the top 10 recommended books on many blogs, there are essentially zero books on strategy, brands, moats, management, industry characteristics, and so on. It may also help to read some biographies of entrepreneurs, executives, and the like.
Ideally, it would be best if all of us were also businesspeople, executives, or entrepreneurs. As you highlight from Buffett's remarks, he is a better investor because he was also a manager of several businesses. But this is not possible for most of us and, even if someone were in such a position, I don't know how many would still pursue investing (financial rewards from running the business would mean that you become an investor for personal interest/challenge rather than money.) Given our limitations, I think the best we can do is to emulate and try to be a businessperson; and conversely, a businessperson might want to think about investing. In any case, this is a serious downside to all of us who don't have exposure to both.
Sunny:
Simply, most investors do not have the time(if they work fulltime) to do this and those who are professional investors(the majority) are focused on diversification and not taking a real risk. Managers that really spend time to understand the business, competative advantage and so on...STILL make huge mistakes because the future is impossible to predict.
Also, Buffett has characteristics that other people simply dont have: patience and willpower. Most people cannot sit and wait 5 years while everyone passes them by with better returns trading in a bubble and do nothing while in Feburary when Citigroup is going under and the market is going hitting new lows, few people had the courage to invest.
To me, there is a logical part to investing (in doing dcf calcualtions,studying marketshare...etc) and a part that relies on 'instinct' to make the right decisions.
I don't believe the points you make in the quote above are as bad as it seems. What you are saying is true but it mainly hurts professionals. It can hurt the individual but if they can't overcome certain issues—such as being patient or willing to take quotational losses—they simply won't be value investors. I'm not trying to be arrogant or anything but such people will likely never succed with Buffett-like strategies (other strategies, such as momentum investing, may work for them.)
Very few are as patient as Buffett—sitting on the sidelines for 5 or 6 years in the late 60's—but I think most small investors can probably do it for 2 or 3 years. Professionals, on the other hand, will have a tough time. If you underperform for more than 5 or 6 quarters, your job may be at stake.
I also think the lack of time for most amateur investors isn't as bad as it seems. If you are really trying to beat the market, there probably aren't that many opportunities worth investigating. Also, let's not forget that if we keep our circle of competence somewhat small, you will have plenty of time to research opportunities.
To wrap up, I think you touched on important points every investor should think about. First and foremost, Warren Buffett doesn't just look at a company; he looks at that company within a competitive business environment. Understanding the industry and why that company appears to be more profitable is just as important as knowing how good that company is. It would help if we are both investors and businesspeople but very few of us are and that is a handicap for us. As for other traits possessed by Warren Buffett, such as patience, ability to pounce on infrequent ideas, and the like, I personally don't think that is much of an issue for amateur investors. All of us can decide on our own how much to invest, when to invest, for how long, and in what asset. No one is forcing you or I to do anything. The same cannot be said for professionals and that is a huge negative for them.
That is a great post Sivaram and I could not agree more. My business background is Corporate Planning and got to know about value investing after trying to understand how Berkshire and Teledyne had such great track records. Getting hooked on value investing was a consequence on that.
ReplyDeleteIt is not that difficult to find a great business, most of the time the issue is WHEN to buy those great businesses. Pfizer and Ticketmaster are two of them that I can not understand why not more people are talking about them.
I specially recommend reading Ch 5 of Fisher's Oaths to Wealth through Common Stocks that mixes brilliantly value investing with competitive strategy. That is a great idea for a post.
Yep, good knowledge of investing & business goes a long way... I haven't read Fisher's books yet :( but hopefully will at some point.
ReplyDelete"Pfizer and Ticketmaster are two of them that I can not understand why not more people are talking about them"
Medical companies are outside my circle of competence so I didn't look deeply at it but the problem with Pfizer is that it may be looking at a secular long-term decline. Even if you were bullish on healthcare as a broad sector, there is little to indicate that old-school drugs are the way to go. Some of emerging things in biotech, genetics, and so on, may grow while conventional drugs stagnate.
Furthermore, Pfizer is way too big to easily "turn around" or growth much. Even if you were a contrarian investor and think the company will do better, a doubling of the stock, as an example, seems remote. It's hard to see a $100 billion market cap going to $200 billion.
To me, Pfizer is only attractive as a "utility" that generates stable cash flow.
Ticketmaster is more complicated (in a big picture sense) and I think that's worth investigating. I looked at it when I was looking at Expedia earlier in the year and thought it was an interesting stock. I don't like the corporate governance (sort of the same as Expedia) but it is essentially a monopoly (or a duopoly at worst). The market is obviously concerned with potential government crackdowns and emerging threats (possibly on the Internet). It is also possible that it is not understood well given how it was spun off just a few years ago.
TKTM could turn out to be Buffett's Washington Post--distressed, ignored by everyone, but owning a rare monopoly. Now that you mention it, I'll take another look at it soon.