Saturday, November 16, 2013

Why go Buffett?

There seems to be an unspoken (but often implied) mantra in value investing that beginner investors start with asset investments and then once they learn the ropes and grow they graduate to real investment, buying great companies based on earnings or free cash flow.  A special few graduate to the highest honors of value investing, special situations, catalysts and bankruptcies.

I was attracted to the idea of value investing because it appeared so simple, purchase something for less than it's worth.  When I first encountered this it was so obvious, I couldn't believe that everyone in the market wasn't investing like this.  Purchasing something tangible for less than it's appraised value is something most of the population can grasp.  People will brag about the great deal they got on a pair of pants, or how they purchased a house out of foreclosure and saved a lot of money.  Buying an item at a discount to salable value is not a foreign concept to anyone, except participants in the public markets.  Market participants will bend over backwards to explain all the reasons a company should sell for less than book, or NCAV.  

Fortunes are made and lost in the market on a whim.  To make a fortune outside of the market you need to either marry the right person, be born in the right family, or most often work hard for sweat equity.  I've never heard of a young intelligent person starting a business, and within months turning the little local Carpet Barn into a billion dollar fortune through their raw intelligence, yet these sorts of stories percolate around Wall Street often.  A young fund manager can become famous from a single year of outperformance, or a single great trade.

For many it appears easy to make money in the market, do some reading, invest and profit.  The market's greatest spokesman, and one of the world's richest men doesn't help, Warren Buffett's folksy explanations of value investing are simple, but I feel miss the point.  I don't talk much about Buffett on this blog because I'm not sure if there's much to learn from him.  This might sound strange to say, but I put Buffett in a class of his own.  Buffett is a superstar investor, he is the Ussain Bolt, or Michael Jordan of investing.  Are Ussain Bolt's tips on running going to help me run any faster for my Thanksgiving race?  Probably not, no matter how simple they are, Ussain Bolt is naturally more gifted than I am.  I enjoyed reading The Snowball and Buffett's annual letters, but I don't believe he can be replicated, he's naturally a great investor, I don't have that same gift.

Given Buffett's success it's no surprise that there are legions of investors attempting to follow in his footsteps.  The problem is his footsteps are unclear, is it cheap stocks like he did in the 1950s, is it his concentration, is it his ability to discern great management teams, or his ability to take advantage of opportunity?  Everyone seems to have a slightly different take on what made him successful, and there is no consistent pattern to follow.

Buffett most recently has been preaching that investors should be buying great companies at good prices and let them compound.  Math is in his favor with a statement like this, it's impossible to argue against buying a company that continually compounds at 15-20% forever at a good or cheap price.  The issue is these companies don't sell at low prices often, and when they're priced low it's usually due to an issue or problem they're facing.  In my view claiming that the company will come out unscathed and continue on their unrelenting compounding journey is hubris that's often reinforced with hindsight bias.  No one knows the future, at best one is making an educated gamble that the future will resemble the past, with the twist that an investor is hoping any issue is resolved without incident.  We've lived in an unprecedented age of prosperity in America since the 1940s which has provided a nice tailwind for this style of investing, momentum is hard to change.

The mere fact that the world's most successful investor preaches a particular philosophy is reason enough for most investors follow after him prowling around for great businesses at good prices.  My view is that just because Buffett does something doesn't mean that everyone else can do the same as him no matter how easy he makes it seem.

What I don't understand is the general disdain for asset investing compared to Buffett's growth value investing.  The research bears out that simple value strategies like net-nets, or low P/B stocks outperform the market significantly.  In the book Quantitative Value the authors make note of a study that showed that if one were to take all stocks at less than 1x book value, short the ones with a low F_Score and purchase the ones with a high F_Score they would outperform the market by a whopping 20% a year.  The problem is doing something like this is too simple for most investors.  They want a challenge and buying and churning through cheap stocks isn't enough for them.

I like to think of value investors who follow in the footsteps of Graham are the antique collectors of the market.  We are digging through flea markets looking at old baseball cards hoping to luck on a mint condition Mickey Mantle rookie card.  We never quite find that Mickey Mantle card, but we do find a lot of Wade Boggs and Jose Canseco cards which if purchased cheap enough can be flipped for a nice profit.  The Buffett school of investing continually visits flea markets until the Mickey Mantle is found.  The problem is if one might not know exactly what mint condition constitutes, or how to tell the difference between an authentic and fraud card, and eventually overpay for their Mickey Mantle rookie card.

For me investing is a means to an end, it's a way to prudently manage extra savings and grow it at a rate above inflation.  When I need the money at some future date I hope to have more, I don't think I'll care much about how I got there, either by net-nets, low P/B stocks, or growing a business.

I'm not sure if this post has much of a point, maybe it's really a rant against an attitude I see a lot.  My question to you is: "Why so much disdain against a proven investment methodology, that while simple has historically consistently high results?"


64 comments:

  1. Good post. I agree trying to emulate Buffett is a bit ridiculous.

    I like a mix of styles (all value-tilted), but I feel most "secure" in my asset investments, rather than my attempts to discern a great business at a great price.

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  2. Did you post your performance numbers for the recent years somewhere? :)

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    1. I'm not sure I understand this comment, but no, I've never publicly posted my performance. I will tell you the same thing I tell everyone who asks, my goal is to do 15-20% a year, in excess of 15% is the target, and I've been able to hit it.

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    2. Over what time period have you measured your performance? How does it compare to the S&P 500 over the same time period?

      - aagold

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  3. "The market's greatest spokesman, and one of the world's richest men doesn't help, Warren Buffett's folksy explanations of value investing are simple, but I feel miss the point."

    Thank you for writing this. I have long felt the same way.

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  4. I think the other point is that WB moved into the 'great business at a good price' style because he needed to put lager amounts of money to work to move the needle...

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    1. This is very true as well, his pool of potential opportunities is getting smaller and smaller.

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  5. I think the essence of the theory is simple, but application is difficult. It's like understanding Bernoulli's Principle vs. Building An A380.

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  6. Before I answer to your question I'd like to thank you for the time and effort you put into this blog. I love reading you writings and I have learned an enormous amount of things from you.

    So thank you.

    Now as far as your question goes I have two things to say:

    First I don't agree with what you call the unspoken mantra to value investing. To the contrary of what you say asset investing isn't only the most widespread form of value investing but also the most loved one because of its quantitative "purity", the bucket approach and the use of objective criteria that help one pick companies.

    Just take a look at the approach most successful value investors use. Seth Klarman is an asset investor. Howard Marks and Joel Greenblatt are distressed and special situations investors.

    Apart from Buffett, Manger, Combs, Wechsler (so far all Berkshire) and Monish Pabrai I can't recall anyone else that successfully follows the moat approach.

    There are several others like Prem Watsa, Drukenmiller, Berkowitz, Ackman, Chapman and many more that may be characterized as "value investors" but they are not. They are fundamental or activist investors but not value investors.

    What's the difference between fundamental investors and value "moat" investors? The former create a model of the business they study and try to predict the future. The latter focus on the competitive advantage and how to not overpay.

    Second, I agree that Buffett with his folksy demeanor may be a little misleading. But this is because many people take what he says lightly. For example when he states that he took 10-K's to read in the bathroom instead of Playboy he MEANS it. Apart from the two investors he hired (Combs and Wechsler) I haven't heard of anyone else that copied his habit of reading up to 1000 pages of financial statement and data per day.

    The key to understanding Buffett lies in a phrase used by Manger: "It's simple but it isn't easy."

    And it shouldn't be. To be a successful "moat" investor you must be first and foremost a businessman in your thinking and attitude. There are too few investors that can claim to think like that. The only one renowned investor I could find that thinks like this is Monish Pabrai and that is because he was a businessman before he was an investor.


    Concluding this I'd like to restate that you are wrongly frustrated about how the world treats asset investing. Most people just don't have the temperament needed to follow this discipline. I don't follow this investing approach and I've tried, believe me.

    I can bring myself to hold 50-100 companies in my portfolio and I definitely can't stand the Idea that a company is losing value as time passes by. Finally I like too much running a concentrated portfolio (10 position max) and I can cope with enormous volatility easily when I believe in the future and the quality of the business (and that is potential trap too) I'm invested in.

    Thanks again for the wonderful job you do at this blog. I love to read about your thought process and your investment analysis despite that I don't follow them most of the time.

    Best Regards,

    Gregory Vousvounis

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    1. Good points, I would actually agree with you that buying a company with a competitive advantage while small and hanging on for the ride is probably the best route to investment success. I'd go one step further that an even better route is to start that business yourself.

      Competitive advantages are difficult, ask anyone who's started a business, not just an armchair expert. A local hardware store is supposedly a commodity business, yet if you open a store down the street and match the prices, or even beat them by a few percent it doesn't guarantee success, in many cases failure is assured. The local commodity hardware store might have a local advantage, expertise, hard to find parts etc. Things like this are unknown to investors reading 10-Ks, yet to practicing business people they are well known facts.

      I think you hit the nail on the head, we each need to find what suits us best. In your case asset investing doesn't. My complaint is many people don't find what suits them, instead they blindly follow Buffett because of his success.

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  7. I like the Michael Jordan comparison. If you play pickup basketball you'll see most guys trying stuff they saw on sportscenter and throwing up airballs. Common sense and math tells you the way to win is to not turn the ball over and wait for easy layups, and the guys who do that tend to do well even if they aren't tall or athletic. But for some reason that style never catches on with most players.

    I saw that someone had calculated that Berkshire's equity portfolio had done about 14%, and the rest of the out-performance had come from leverage. If that's true then Schloss actually beat Buffett percentage wise.

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    1. Great point on the pickup basketball game, so true. I remember when I was a kid playing pickup baseball we'd try to imitate some of the batting stances of famous players, we mistakenly thought that if we held our bat in a funny way we'd be able to hit better, of course it didn't work, but we tried and tried.

      Really interesting point about Buffett and leverage. Schloss did very well, I know of a few individuals who've invested in a similar style who've done the same or better than him, all flying under the radar quietly.

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  8. If you look at the investments that made him wealthy that are all of the high quality type. American Express, Disney, GEICO and Coca-Cola are ones that he made huge returns on I can't recall a single net-net coming to mind and he called Berkshire Hathaway one of his worst investments. Also in his most recent conversation with Charlie in Fortune magazine he stated one of the most important things he learned from Charlie was to pay for quality.

    Munger convinced Buffett, 83, to learn to "make silk purses out of silk." And that philosophy has turned out to be a key to the two men's extraordinary investing success.

    "Forget the sow's ears," says Buffett, who applies the "silk purse" credo to all his relationships in life."

    Can everyone do it? No certainly not but certainly a group of smart investor with the right temperament can.

    PS; As you say there is nothing wrong with buying NCA stocks either. At my firm we have buying them since 2009 and they have provided nice returns.

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    1. I think you inadvertently proved my point. I agree that a small group of people can do what Buffett has done, they are the entrepreneurs who've grown tiny specs of thought into billion dollar companies. But it's a small group.

      My point is that the vast majority of investors are trying to copy what might only be appropriate for a small group of people. Yet the type of investing that's simple and accessible for almost everyone is ignored by the masses.

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    2. Haha I suppose I did. Thinking on the subject more I don't find quality company investing to be all that difficult. Finding quality companies is fairly easy its the waiting for them to have some sort of issue that hits their valuation that I find to be the hard part. I would think an excellent investment program would do both. Invest in quality companies when they have temporary problems that don't harm their franchises while also buying NCA stocks.

      I would also suggest that NCA investing isn't quite as simple as it seems. We do the traditional Ben Graham method of buying at a discount to NCA and those just don't show up that often in the US (though lots show up in Japan). The calculation is certainly easier though...

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  9. Nate. Great post. It echos a lot of my setiments.

    "The problem is his footsteps are unclear, is it cheap stocks like he did in the 1950s, is it his concentration, is it his ability to discern great management teams, or his ability to take advantage of opportunity?"

    My own feeling is that with Buffett, everything depends on context. You can't just take what he says and apply it off the bat, because it depends so much on contemporaneous factor. For example, there's a story about how he created a portfolio of Korean stocks. The catch is that at the time the Korean stock market was on some crazy average PE of about 3.

    I think that perhaps the most important book on investing ever written was Greenblatt's "You Can Be a Stockmarket Genius" book. I have much to learn by reading, re-reading and reading again. I think that there is much that a reader cannot do ... for example, I think there are limited opportunities for spin-offs in the UK (ALTHOUGH I WOULD LOVE IT IF SOMEONE WERE TO TELL ME THAT THEY WERE HEAVILY INTO UK SPIN-OFFS AND WHAT THEIR SEARCH MEOTHODOLOGY WAS), I think that there are probably some opportunities in distressed debt but it is more an insitutional game rather than something that private investors could get involved in. I think a really promising area is restructuring - although I'm tending to spot them after the fact, and then kick myself with "if only".

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    1. I like your post. I think I would sum it up as people should buy value where ever the discover it. It should make no difference if your buying quality cheap or net current asset type stocks (or for that matter any type of security you can understand)... Paying .75 (or whatever price you like) for a dollar of value is all that matters.

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  10. This is an awesome post dude. If people want to by great businesses at good prices then let them. It means asset Graham/Schloss investors have less competition to deal with. I'm not actually sure if most value investors are asset focused like Gregory suggests. I'm not actually sure that people who call themselves value investors are in fact value investors. But I agree with the theme of your post.

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    1. Great businesses can still be bought at value prices. If not then the world would call WEB a growth investor and not a value investor. There is no reason that you can't be an opportunistic investor and do both.

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  11. I think most Buffett followers focus too much on what he is doing now and forget the more important question: what would Buffett do if he was in your situation? Your personal situation as an investor dictates the strategies you can use. For example: if you manage a small mutual fund I think it would be very difficult to invest in the way Paul Sonkin did in his Hummingbird fund (mainly in very cheap, but very small and illiquid stocks). If there is any chance of significant redemptions by investors you probably can't do much in the most illiquid names. If you purely manage your own money this would not be a problem at all.

    I think Buffett's old partnership letters are a great resource. This gives you a better idea of what he was doing when he was managing relatively small sums and it is therefore more comparable to the position most private investors find themselves in.

    Also, I think Buffett is overstudied by investors. I certainly spent too much time reading books about him, watching interviews, etc. I should probably have limited myself to the partnership letters, the annual letters and The Snowball and then just move on to other investors and other subjects. All the extra stuff I read about him probably didn't add much. I think I remember reading in The Snowball that Buffett himself had a strategy of studying succesful people and learning all he could from them, but after he felt he did, he would just move on and find a new subject.

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    1. You'll find the best and most comprehensive pieces of advice for Warren Buffett in... Alice Schroeder's talks and interviews.

      In particular check the ones below and you'll be amazed by the quality of insight that she gives.

      http://www.youtube.com/watch?v=PnTm2F6kiRQ&list=PLGfUAJfpwsp7MydH1vQgdy-zaioDxTluw&index=1

      http://www.youtube.com/watch?v=UhON53uAIAE

      http://www.youtube.com/watch?v=0vGsuHYPWbY


      While he is as you say the most overstudied investor there are a lot of things about him and his investment process that are either misunderstood or not well-known.

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    2. Paul, very much agree. The marginal knowledge gain from reading anything else on Buffett is pretty close to zero at this point for most investors.

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  12. This is a great post, I have felt this way for some time. It's is something I struggled with for a while, saying to myself things like:

    Warren Buffet never wrote blog posts, so why do I need to?
    Warren Buffett never used Excel spreadsheets so why do I need to?

    Well because... you're NOT Warren Buffett!

    I have learned much from his writing but have gotten to the point where I would rather read a blog write-up on a micro-cap stock than watch him on CNBC for a couple hours.

    I also haven't grasped why people endlessly analyze his latest moves like Heinz, Burlington etc. Individual investors' time is much better spent studying companies from his early years like Sanborn Maps and Mid-Continent Tab Card Company. Even he will tell you to invest in micro-caps if you have small sums of capital.

    I'd personally like to try and find the next See's Candy than reading a case study on it 4th of 5th time. No easy task, but worth the effort in my opinion.

    Mackie

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    1. Brandon,

      I agree, his audience isn't any investor with a small (less than $1b) of capital. There is a lot more value added finding new interesting companies rather than rehashing the set of large caps he can invest in.

      I like your approach, seeking out the next Sees Candy is probably a much better use of time verses my looking for cheap stocks, but it's just not something natural to me.

      Nate

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  13. What everyone misses about Buffett is that he's a businessman, a fairly ruthless one, with a sophisticated business model.

    He's match-funding equity positions such as Coca-Cola using insurance and reinsurance float, typically at a negative cost.

    Most people think he's simply buying Cola-Cola; but the leverage behind it is invisible to them. In being leveraged, the predictability and stability of cash flows are much more important than absolute returns.

    Most people miss that many of Berkshire's buyouts are de facto liquidations, rather than picks of growth businesses. For example, the manufacturing companies (Dempster, Fechheimer, Scott Fetzer, etc.) are classic private equity investments — more Gordon Gekko than Ben Graham.

    Making money is one thing, and keeping it is another. How Buffett made his money is fairly glossed over. What's glorified is how Buffett keeps his money, which isn't terribly relevant for the vast majority of people.

    What got Buffett to $40 million isn't what got him to $400 million, and the latter approach isn't what got him to $40 billion. In contrast, most people are trying to figure out how to get to $400,000.

    Rarely discussed is the influence of Buffett's powerful U.S Congressman father, the benefits of an establishment WASP background, the value of the relationship with Katherine Graham, pulling strings to save Salomon, and so on.

    Lastly, one of the big taboos, is whether or not Buffett relied on any insider information to generate his partnership returns during the 1960s?


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    1. What a great comment, this hits on so many things that I agree with. Honestly this comment is the elephant in the room for Buffett, leverage, government connections, other connections and potential insider trading.

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    2. "Rarely discussed is the influence of Buffett's powerful U.S Congressman father,"

      Oh please. Howard Buffett was a local stockbroker and served as a junior House Rep. (only three terms) as a libertarian/gold standard purist. He was never a part of DC inner-circles and on the extreme fringe even within his own party. His political position was akin to a one-person Tea Party w/out all the loony social conservatism. I'm sure it was very lonely.

      "the benefits of an establishment WASP background,"
      The Buffetts were middle-class (at most upper-middle?) white people from Omaha. You know, 'fly-over country'. No prep schools or Ivy League for them (WEB himself transferred and graduated from UN-Lincoln, perhaps b/c he didn't fit in socially at Wharton). The parents were hardly in a position to pull on the levers of power for their children.

      "the value of the relationship with Katherine Graham,"
      This is legitimate. But this relationship formed after Buffett was already rich. I have a feeling it granted more social cache than any monetary benefits gained through networking.

      "pulling strings to save Salomon, and so on."
      Did he pull strings? Even if Salomon had failed, I don't believe it would have been a huge setback for Berkshire as a whole.

      The real keys to his success were having the fortune to work closely with Ben Graham at the beginning America's Golden Age and the convincing wealthy Omaha doctors to let a 22-year old invest their money (something that would occur at a much lower likelihood in this day and age).

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    3. Imagine if you walked into GEICO in the early 1950s to talk with the CEO. Your father happens to be a U.S. Congressman, who managed a presidential campaign of conservative Senator Robert Taft. Do you think this might be an important calling card?

      So much of life is simply getting in the door, whether it's meetings, raising capital, networking, whatever. The nuance of political power is that it opens doors — how power is converted into money.

      To claim that Buffett didn't benefit from an establishment WASP background is being unaware of what those social benefits are. It can be seen in his attending Wharton and Columbia, which were a country club in those days, and opened the door for raising capital.

      But more importantly: How about Buffett's dealings with insurance regulators in his 1970s roll up? How about his relationship with Munger's law firm, and their dealing with courts throughout the 1970s? How about all the nuances of acquisitions?

      As the corporate raider Saul Steinberg said: "I always knew there was an establishment, but just thought I was part of it."

      Warren Buffett is the other side of that coin. One doesn't just walk in, gallantly write a check, and acquire National Indemnity, Wesco Financial, or See's Candies. There is a social element in even beginning the conversation, let alone consummating a deal. It's the difference between prostitution and marriage.

      With Salomon, Buffett made a phone call to Treasury Secretary Nicholas Brady (himself a WASP elite), who crucially allowed the business to re-open as a primary dealer in Treasuries, without which there would've been a run on the bank.

      Afterward, Nicholas Brady joined the board of Cap Cities, and became a member of Augusta National country club, of which Buffett is a key insider. This is how the real world works, on Wall Street and in Washington.

      It's not to diminish Buffett's skill level. But those things play a major role in differentiating the "merely successful" people — like those worth tens of millions, or hundreds of millions, or low billions — and someone like Buffett.

      Buffett is about power, platforms, and empire. Those are entirely different from money alone...



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    4. First, I agree with 90% of your original comment: Buffett is not a perfect angel, the saccharine PR tripe can be tiresome, and the usage of hidden leverage aided Berkshire's growth enormously.

      "Imagine if you walked into GEICO in the early 1950s to talk with the CEO. Your father happens to be a U.S. Congressman, who managed a presidential campaign of conservative Senator Robert Taft. Do you think this might be an important calling card?"

      I imagine that being a star pupil of a prominent GEICO Board Member would probably help my self-introduction more than being the son of a former, no-name Congressman. And wouldn't it have been gauche for Buffett, at least initially, to have even attempted to name-drop his father in that setting?

      "So much of life is simply getting in the door, whether it's meetings, raising capital, networking, whatever. The nuance of political power is that it opens doors — how power is converted into money."

      I couldn't agree more and the Catherine Graham relationship probably did pay some dividends in this regard. But that was in middle age. I just don't see where Buffett successfully leveraged his father's short political career or his rather unremarkable family background. If we are speaking of general knowledge of white collar norms or professional etiquette (speaking with correct grammatical syntax, etc, etc) then, yes, Buffett had that benefit. But that's a benefit much, much more widespread than membership in an elite WASP Establishment.

      “Saul Steinberg said: "I always knew there was an establishment, but just thought I was part of it."”

      Saul Steinberg's quote is indeed instructive and highlights two distinct points: how exclusive and powerful the inner-circle is, as well as, how opaque and hidden that circle is to those who are not a part of it. Not only were the Buffetts most certainly not a part of this ultra-elite establishment, they weren’t even close enough to it to entertain the idea that they themselves were part of it!


      "But more importantly: How about Buffett's dealings with insurance regulators in his 1970s roll up?"

      Don't know the particulars on that, but by the same token, didn't the SEC go after him pretty aggressively around this timeframe? My recollection of how this was characterized in Snowball is that the basis for litigation was essentially that the SEC simply could not believe that Buffett's plain, forthrightly stated intentions were truthful. In other words, he was treated with a wary eye because he was not an insider.


      “To claim that Buffett didn't benefit from an establishment WASP background is being unaware of what those social benefits are. It can be seen in his attending Wharton and Columbia, which were a country club in those days, and opened the door for raising capital.”

      Agree with the country club reference and to some extent they still are (though multi-ethnic). But even within these institutions it's tiered: all the benefits are at the top. Buffett though was on the fringe. Did he have multi-generational family legacy bona fides? Membership in a prestigious fraternity or dining club? For crying out loud, he probably couldn't even snag a date there. Definitely not a laxbro.

      Buffett became a firmly entrenched Insider at some point in his middle age after he was extremely wealthy. But that has nothing to do with a WASP establishment—a term conspicuous, in modern day usage, in its omission of Jews.

      Buffett's nominally Christian background nearly excluded him from working for Graham. It would have been an absolute bar, but for Buffett's persistent nagging. How does one reconcile 'WASP entitlement' with a fact such as this?

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    5. The point is simply that Buffett came of age in the world that was hospitable to him. He was very well positioned to seek opportunities.

      I'm not saying that he was a Whitney or Harriman and everything was handed to him. But he had the necessary ingredients to advance in the society of his day.

      Having a father who is a U.S. Congressman was important in the society of the 1950s. Family money is more important in today's society.

      Perhaps a modern equivalent would be someone like Einhorn or Ackman. They were well positioned to advance in today's world, and started from a solid base.

      To continue with the analogy, noting Ackman and Einhorn's family financial backgrounds isn't implying that they're comparable to the Warburgs and Rothschilds. The point is that it positioned them competitively in the Wall Street of which they came of age.

      That's all I'm saying about Buffett. He was positioned competitively in the 1950s and 1960s.

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  14. Nate, why not heed Buffett in this regard? He has given very honest investing advice for people like us:

    1. For the average person he advises to dollar cost average into index funds: http://www.youtube.com/watch?v=idr6c8NHuWs

    2. For a small time active investor he advises classic Graham type stocks: http://www.youtube.com/watch?v=BLCjbclBmMk

    Buffet has been very clear in this regard. There is no need to argue this further............. CASE CLOSED

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  15. nate i think one thing to consider is WEB is adaptable, why do we feel the urge to label or lock investing into some rigid thing? it has to be "great business", or low pe or great management, net-nets?

    it simply buy something worth more than what its selling for. the goal is to find these "situations"

    investing is a complicated multifaceted, very few can excel at all its facet. some maybe can master 1 or 2 or a few.

    to each his own

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    1. Definitions help give context without needing to repeat ourselves and give as much background, but I do agree in some senses.

      I met an investor from New Zealand while skiing last year, I said I was a value investor, he asked what it was. I explained intrinsic value, and he said "you're doing what every investor is trying to do, buy something for less than its worth, nothing new"

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  16. I can tell you why i am not a real asset value investor. I like to clone other people and i like to get paid while waiting. Most if not all Net-Nets don`t pay dividends, and when i try to clone you, i have the impression that i am always late to the party (and when i am not, i think about if the asset is undervalued for a reason not going away.). Doing net-net research myself is to hard for me currently and i think you have a clear advantage because you can unlock value in microcaps with a simple blog post.

    Following WB is easier for me. :)

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    1. You are honest with yourself and know your personality, so you found something that fit. I have no disagreement with that. But you also aren't out trying to best Buffett either.

      Microcaps are unique in that any attention they get can unlock value. If Sonkin, Norberg, Gabelli, or many bloggers mention a company it suddenly attracts attention. In most cases all a micro cap needs is attention for value to be realized.

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  17. An interesting conversation. I think the most return will be in activities others can't or won't do. The more popular the Buffett approach becomes, the smaller the excess return. The same is true for all strategies. Its competitive strategy in asset management. So the best strategy is to find one that fits with your personality and that is not popular now.

    One type of investment that doesn't get much attention in value circles is stub (or levered) equities. This type of investing requires both HY analysis along with equity analysis. I have only seen it mentioned in 2 value investing books, Greenblatt's "Investing Genius" and Mihaljevic's "The Manual of Ideas". The misperception is that this type of investing is risky because the fundamentals can appear to be risky but the price reduces the risk. The challenging part, is how to value the increased fundamental risk.

    Packer

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    1. I think that value investing is relative antifragil in this regard. As long as you don`t lower your margin of safety, more "value" investors can essentially lead to a faster realisation of fair value. And that is independent if you are an "asset" investor or an "earnings" investor. I would say that it depends on the stock if an asset or an earnings valuation is better.
      "To the man with a hammer every problem looks like a nail" :D.
      When i look at something like http://www.oldschoolvalue.com/stock-screener.php than i think that after a crash its best to invest in "asset" based stocks, but in other times it seems better to invest in "earnings" stocks.

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  18. Where is no need to emulate Buffett, just buy BRK stock and invest EXACTLY like Buffett.

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  19. It's really easy to emulate Buffett. The one problem is that Buffett got started in an environment where stocks were yielding 33% - 100% on FCF. One becomes wealthy fairly fast once liquidity entered the markets and repriced everything. We'll eventually get wealthy as him if given enough time ;)

    What people don't understand about Buffet is that he is literally a walking permutation calculator. Throw in all that reading and you got someone who can decide whether he'll purchase a business or a block of stock within 5 minutes. Patience and the ability to make large moves during times of extreme panic is something that a few can do (most people are on margin or lost their jobs and have to live off savings).

    All you need is one or two trades to be set for life, but people have the need to always be doing something when the best course of action is to sit down and read...

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    1. Really easy? If that's true where are all the little Buffetts running around? There are many who have emulated Graham's success by investing just like him, but where are all the mini-Buffetts who have done just as well or better?

      I agree that a lot of his success can be attributed to being in the right place at the right time with the right temperament.

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  20. It's going to be very interesting to see what comes out about Buffett, if anything, after his death. It seems that most people are either engaged in worship of him, or perhaps fear.

    I have met Buffett in person, in a business context, and he struck me as much different than the popular image. In fact, we left with an eerie feeling about him, although it took time to sink in.

    Similar to political leaders, most people are awestruck. But after such an individual is gone, usually a more nuanced picture emerges.

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    1. It will be interesting for sure, often people won't say something about the living out of respect, but those stories always have a way of coming out after their death.

      I'm fascinated by your meeting with Buffett, what was it that left a strange feeling? Something he said, how he acted?

      I think many people's impressions of him are clouded by their worship of him, he's just a person like anyone else.

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    2. Buffett was very, very focused. Based on my short impression of him, his personality struck me as similar to Hank Greenberg of AIG: no nonsense, tough, driven. I guess this shouldn't be a surprise, since both men are in the same industry.

      No one will doubt Buffett's sharp mind, especially at his age, but he also seemed like a fairly sour and dark man. This aspect about him seems eerie, and I suspect most people only piece together over time. He creates sort of a cognitive dissonance effect, which people seem to rationalize in different ways.

      Alice Schroeder, I believe, has had second thoughts about him since having some distance. She made a comment like "you don't become worth $40 billion by being Mr. Magoo".

      I don't think anyone really knows how Buffett got as rich as he did. His real money came out of the 1960s and 1970s. He went into the period being a miser with stock-picking skills, and a substantial personal savings. But he came out a tycoon…

      By the late '70s, I believe he was worth hundreds of millions, and his trajectory was basically set. The 1982 to 2007 bull market would've made him a multi-billionaire anyways, if he simply earned the S&P return and reinvested all his profits.

      The important questions are what Buffett was doing in the 1960s and 1970s, and realistically, there's not much information on it.

      The book "Damn Right" has a decent picture. Munger did deals like tax shelters on oil wells, leveraged real estate development, working from the stock exchange — lots that is a departure from the typical storyline. While this isn't Buffett personally, the implication is that they were much more aggressive in their younger days.

      Buffett's partnership days are vague and secretive. The details of his arbitrage approach are vague or unknown. His insurance roll-up days are vague and forgotten. But those are the main areas where his money came from...

      I once heard George Roberts of KKR say that "Buffett has warts", without specifying more. People respect Buffett, or fear him, but will never really say anything.


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    3. I totally agree.

      There are some things about him that get lost behind his public grandfatherly persona. He is a very tough and ruthless businessman and that's something that essentially no one talks about (even Alice Schroeder stopped after a while).

      An example of that is how he bought National Indemnity. He found out that the owner (Jack Ringwalt) had some moments ("15 minutes every year" goes the quote from Snowball) when he went into rage and wanted to sell the business.

      Buffett had one of the company's board members to watch Jack and notify him when this 15-minute window opens. One day he received the relevant call and went immediately to the company and talked Jack into selling it to him.

      He agreed to EVERY condition Jack set for the deal, he agreed on the price, to not fire anyone, to not move the company etc. etc.

      He knew that Jack was a man that would NEVER go back on his word and when he changed his mind about selling Buffett just didn't give him any footing to cancel it.

      He deposited the money within a week and with a one page contract he essentially pushed this guy to sell him his business. If that isn't ruthlessness and manipulation I don't know what is. And he applied similar tactics to buy the Nebraska Furniture Mart, Clayton Homes and many other businesses.

      However don't get me wrong on this. Buffett didn't trick Ringwalt he just outsmarted him in the negotiation. He keeper his word about everything he promised and didn't cheat Ringwalt on anything.

      You see while he is a tough businessman and a man devoted to his own interests Buffett never did any shady dealings nor broke any law. He just is/was a very tough negotiator and made sure that every deal he made was to his own best interests.

      Can't blame him for that can we?

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    4. It's very difficult to know what Buffett was doing in the 1960s and 1970s. However, I sense that a move he pulled might have been one which sunk Reliance Industries, a former insurance company.

      Buffett might have used National Indemnity, as well as numerous other insurers that he rolled up, to generate a massive amount of float, through looser underwriting standards. He then used this upfront cash to purchase stocks like the Washington Post. But later in the '70s and early '80s, he was running underwriting losses, from bad policies a decade earlier.

      It's hard to know if those losses were intentional: meaning he used float essentially as margin. The difference is, unlike Reliance, Buffett made hundreds of millions from his stock and bond picks. If this is true, it also saved Buffett's ass from the sinking textile mill.

      Another thing I question is whether Buffett was the "Ivan Boesky" of the 1960s. He had a great network in New York City, and would visit regularly and receive information. It's just assumed that this was fully legal, despite lax oversight of the day.

      The typical dialogue is that Buffett found great bargains by flipping through Moody's Manuals. This appeals to people's sensibilities, and view of him as a smart businessman. Less clear are situations like his tight relationship with the Goldman Sachs arbitrage desk in the late '60s.


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    5. Arbs were a lot easier 10 years ago, let alone 30-50 years ago. The spreads of those days we can only dream about now. Arbs were so great because you could make 10% in 2-3 months (40% annualized) without any leverage... So add a little bit of leverage on deals you knew were certain of closing and you could compound your money so fast.

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    6. Merger arbitrage lends itself to insider trading. If anything, it's the primary form of engaging in insider trading. Pairing your statement about spreads with prospective inside information, then you have 40% annualized with effectively no risk. (other than law enforcement)

      I've done a tiny bit of arbitrage, but it likely hasn't been worth it, for the reason you highlight about spreads. Further, I have seen merger arbs collapse before, which could be very painful.

      I believe one of Ivan Boesky's pitches to raise money for his arb funds was that huge arbitrage fortunes existed, which basically nobody knew about.

      Funny enough, I believe Buffett got Scott Fetzer — one of his major homeruns — following a bid from Ivan Boesky, around the time the latter collapsed.


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  21. long time reader, first time commenter

    I tried to invest first in extremely cheap companies but now im investing i quality companies that consistently grow EPS (usually by buying back shares aggressively). Autozone is a fantastic example of this kind of companies. You find 5 or 10 of this companies (Autozone is growing EPS more or less 15% per year during the last decade) and you use a little bit of leverage (50 dollars for every 100 you own; margin lending using Interactive Brokers is more or less 1% annually) and you get rich... without much less effort than your strategy of looking for really cheap things....

    I already invested in cheap companies with problems.... and i dont like it.....

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    1. For your personality it sounds like higher quality companies are better. The question I'd ask is how are your returns comparing with the new strategy?

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  22. Autozone... for example... started trading in 1991... the share price has multiplied by 50 more or less. This is more or less 20% per year (because EPS have grown more or less 20% per year). Using a little bit of leverage u go to 25 or 30% per year. I think it's much better than investing in cheap companies with problems.

    And right now Autozone is not extremely expensive (P/E is 16). Check also O'reilly automotive, Fossil, Mastercard, Union Pacific Corporation, Express Scripts....

    I invest in companies that: 1- are buying back shares in an aggressive way. 2- growing EPS consistently more than 10 % per year. 3- I understand the competitve situation.

    I have looked the financial statements of the 4000 companies trades in the US... and there are very few companies that meet my rules. But with 5 or 10 companies.... it's enough.... to get ridicously rich

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  23. Did you purchase Autozone back in 1991 or recently? I understand the growth stories of these things, and I've said in the past if you can invest in an Autozone in 1991 you're much better off verses buying cheap stocks. The problem is very few people have the ability to identify these companies in advance.

    I purchased Mastercard a little over a month after the IPO, a true moat company at a cheap price. I've hung on for dear life and done well, but I consider it luck. I would have never guessed the stock would do this well. If you look at their financials pre-IPO they weren't even consistently profitable. At the time I thought they were worth maybe $80, by the time they reached $80 their results had improved, I just continued to hold.

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  24. I purchased Autozone at 280 $. They had stg like 120 millions shares 15 years ago. Now they have 34 millions shares and every quarter the number of shares go down. Im not selling Autozone if the business has some kind of problem (I understand volatility is normal in business situations). I will sell Autozone the moment I see that management is not as aggressive in buying back shares as they are now. And if u read the transcripts of earnings calls in Seeking Alpha... u will see that they are very clear about their intentions of buying back shares. I expect the company in 10 years to have 15 or 10 millions shares outstanding. Even if net income doesnt grow a lot... EPS will explode and the share will explode.

    It's not about having the ability to identify these companies. The basic rule is: Im not investing in companies that are not buying back shares aggressivily. And this is it. It's like all the guys in Seeking Alpha obsessed with dividend growth investing (not a bad strategy) but mine is more efficient and tax efficient (u can take money for living expenses through the margin account).

    check the article: carol loomis: beating the market by buying back stock
    and check this guy in Seeking Alpha (more than 100 million investing in dividend growing companies: with a little bit of leverage and buybacks its normal to end up the same or better): mbkelly75

    I apologize for my english. my mother tongue is catalan

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    1. What about a company like WLP? Their share count is down dramatically (at least 50%) while also buying companies for mostly cash. Their competitive situation does not look as good, but the govt isn't going to put the company out of business. Just like banks, WLP will figure out how to make money. I dream (half kidding) of one day being the only shareholder left.

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  25. There are better options. Net income for WLP is lower now than in 2007. So.... even with the big share buybacks.... since 2007 EPS has just grown 30%. Not exactly very good....

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  26. Interesting post.. I think the question of value versus quality is actually separate from the question of a "simple"/quantitative approach versus one that can include qualitative analysis of individual securities. One example of a very simple approach focused on business quality would be a Greenblatt-style Magic Formula strategy, where quality is esimated from measures of return on capital with no further analysis taking place.

    Although there is good long-term evidence for even extremely simple value strategies like price/BV, the usefulness of simple metrics can become temporarily compromised if they become widely used (for example, if all low P/B stocks were indiscriminately bid up, eventually very low quality stocks like fraudulent Chinese net-nets would come to dominate a low P/B screen.)

    You mentioned the book Quantitative Value, while I enjoyed the book I think it's also a symptom of mechanical value screening becoming widely used among various "quant" communities, which will begin to impair the usefulness of simple screens if it continues. This is equally the case for the usefulness of simple "quantitative quality" strategies like the Magic Formula after its aggressive popularization with the unfortunately named "You Can Be a Stock Market Genius."

    Maybe it's not a coincidence that simple quantitative value strategies have actually begun to underperform:

    http://greenbackd.com/2013/06/26/value-is-badly-lagging-glamour-the-value-premium-is-now-a-discount/

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  27. Mohnish Pabrai advises "replicate Buffett" or cloning. Buying a Phil Fisher company at a Ben Graham price is the holy grail, isn't it? So those opportunities don't come around often. Even Buffett says you only need to be right on one or two stocks, and Lynch has said it only takes 2 or three 10-baggers to make a difference. Then you can sit on your you know what, as Munger says.

    Net-nets aren't always around either, so they can be just as hard to find. Schloss and Francis Chou prove the method is still profitable, if done in a 'basket' approach versus concentration. I have no problem with it, but it obviously takes a lot more work finding and compiling a basket of net-nets versus one or two or three compounding machines and holding on for the ride.

    Pabrai even tells the story of Munger saying if you lived in a small town and purchased the car dealership in town, owned the only McDonalds, owned the biggest office building and apartment building in town, you're done. No need to pour over Japanese net-nets!

    Buffett himself has said that you can't make "big money" with Graham net-nets compared to big compounders and if he had $1 million or less he'd be doing probably what he did earlier in his career. So 12-15% compounding returns from net-nets are just fine, but who would be opposed to finding a handful of compounding growers that can give you 26% CAGR as Pabrai advises?

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  28. Have you read "The Warren Buffetts Next Door" by Matt Schifrin? His methods aren't always replicated, but aptitude and diligence can definitely mimic his returns.

    Besides his genius and exclusive focus on accumulating money, I think the big thing is he kept reinvesting his returns in more and more acquisitions, whereas most people probably would continually tap their pile for yachts, extra homes, cars, etc.

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    1. A broader issue is simply being a "survivor". I have seen tons of hotshots in investing, going back to the 1980s. Very few survive.

      On the larger stage, the survivors are all the names that you know. Investing is largely a war of attrition.

      There are strategies (or careers) that work well in a given cycle, but evaporate once the cycle is over.


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  29. There is no value investing, it is only a useful fiction. Investing and speculation are fundamentally indistinguishable. At the end of the day all our activities come down somewhere on the spectrum between a sure thing and a sure loss, everything beyond that is taxidermy. We have to ask ourselves what we want out of our experience and figure out the best way to achieve it, if it can be achieved at all.

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  30. I feel like Buffett's investment philosophy is the most logical and easily replicable. A savvy businessman wants productive assets; buying cheap assets isn't good enough. All it takes is a discerning business mind that understands strategy and valuation. If you think about the market as a whole, people tend to be more attracted to businesses that generate FCF like the soup nazi (but over a longer time period).

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  31. Very fascinating conversation in the comments about Buffet. I have only followed him from CNBC and skimmed through his letters. Especially the comments about his "darker" side were interesting. I haven't read Snowball because I have always thought that it only includes the grandfatherly stories "everybody knows". Is there something else in it about his character than that?

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  32. Sure Buffett are recently preaching that investors must buy great companies at good prices and let them compound. This is an exact reason that everyone go for buffett.

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  33. Nice post Nate. I've been thinking about this myself. I think the flaw in your rationale is that you use market prices to validate your decisions. Let's say stock A, goes up 300% after you buy it. However, it is unprofitable, will never pay a dividend, etc. Let's say stock B, declines 75%, however it has a P/E ratio of 2 and pays a 7.5% dividend. Clearly if you tally the "results", it will be obvious that the results for an investor in stock A, overall, are better. However, if you were a private business owner (ignoring market fluctuations) - clearly you would be the bigger winner in stock B.

    I think there IS actually, in many cases more value (in times when markets are high, as they are now), to buy a company with consistent earnings power (ie is consistently profitable each and every year), at let's say a 10 PE, rather than buying some net-net at let's say 50% of book, that one year might earn 5% on equity and the next lose 5%. Which stock will have better market performance is really anyone's guess. But if you're looking at the business as a private owner, surely you would rather be an investor in company A rather than company B UNLESS you can with a high degree of confidence predict for instance, that the net net will be liquidated at book value and that you will get the distribution within a certain period of time.

    Keep in mind that even when Buffett was buying cigar butts like Dempster Mill, they were control positions in which he could control and predict the liquidation of the unproductive assets of the company. If you're a passive (non-control) investor, you have no choice but to rely on management to make the (hopefully correct) decisions, hence the emphasis on management skill.

    Thoughts?

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