<font color=Crimson>Value Investing refers to a very specific approach to investing
Rather than repeat the reasons a certain much-decorated thread-head is wrong--which have been reiterated often enough above--I thought I'd open one of the horse's mouths instead. Herewith, therefore, are some notes from Robert G. Hagstrom, Jr., The Warren Buffett Way (New York: John Wiley & Sons, 1995), that show clearly just how much similarity there is between value investing, broadly defined, and gorilla gaming. In fact, one could go so far as to say that gorilla gaming is little other than a value investing strategy optimized for certain kinds of high tech markets in which true present value is not captured well through the use of traditional valuation metrics.
Although generally regarded as the greatest investor of the twentieth century, Buffett is often ignored or mocked by online types because of his value-oriented approach, his notorious aversion to the technology sector, and his ultra-long-term-buy-and-hold philosophy. Yet Buffett’s writings, like Peter Lynch’s, are in fact a perfect complement to The Gorilla Game, since they stress the importance of seeking out a very small number of outstanding businesses and then profiting from their cumulative returns over the years. It does not surprise me at all that Moore and his coauthors pay tribute to Buffett’s influence in their acknowledgments.
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“The education of Warren Buffett is best understood as a synthesis of two distinct investment philosophies from the minds of two legendary figures, Benjamin Graham and Philip Fisher. ‘I’m 15% Fisher,’ Buffett said, ‘and 85% Graham.’”(27)
“Graham, the quantitative analyst, emphasized only those factors that could be measured: fixed assets, current earnings, and dividends....He was only interested in developing an investment approach that could easily and safely be adapted by the average investor. In order to limit risk, Graham counseled investors to fully diversify their portfolio holdings....Fisher, the qualitative analyst, emphasized those factors that he believed increased the value of a company: future prospects and management capability. Whereas Graham was interested in purchasing only cheap stocks, Fisher was interested in purchasing companies that had the potential to increase their intrinsic value over the long term....Finally, in contrast to Graham, Fisher preferred to concentrate his portfolio holdings and include only a few stocks....[Buffett’s] investment approach has been to combine a qualitative understanding of the business and its management, taught by Fisher, with a quantitative understanding of price and value, taught by Graham.” (44)
“What Buffett learned from Graham was that successful investing involved the purchase of stocks when the market price of those stocks was at a significant discount to the underlying business value....From Fisher, Buffett learned that the type of business purchased matters a lot. He also learned that management can affect the value of the underlying business, hence management’s attributes need to be studied as well....Finally, Fisher taught Buffett not to overstress diversification.” (46-47)
“In addition to the margin of safety theory, which became the intellectual framework for Buffett’s thinking, Graham helped Buffett appreciate the folly of following stock market fluctuations. Stocks have an investment characteristic and a speculative characteristic, Graham taught Buffett. The margin of safety helps explain a stock’s investment characteristic. The speculative characteristics of a stock are a consequence of people’s fear and greed. These emotions, present in most investors, cause stock prices to gyrate far above and below a company’s intrinsic value. Graham taught Buffett that if he could insulate himself from the emotional whirlwinds of the stock market, he had the opportunity to exploit the irrational behavior of other investors, who purchased stocks based on emotion, not logic.” (48)
“Buffett’s dedication to both Graham and Fisher is understandable. Graham gave Buffett the intellectual basis for investing, the margin of safety, and helped Buffett learn to master his emotions in order to take advantage of market fluctuations. Fisher gave Buffett an updated, workable methodology that enabled him to identify good long-term investments.” (48)
“In Buffett’s opinion, investors are better served if they concentrate on locating a few spectacular investments rather than jumping from one mediocre idea to another. He believes that his success can be traced to a few investments. If, over his career, you eliminate one dozen of Buffett’s best decisions, his investment performance would be no better than average. According to him, ‘An investor should act as though he had a lifetime decision card with just twenty punches on it. With every investment decision his card his punched, and he has one fewer available for the rest of his life.’ If investors were restrained in this way, Buffett figures, they would wait patiently until a great investment opportunity presented itself.” (67)
“Buffett is remarkably unconcerned about the price performance of his common stocks compared to a stock market index. He judges the success of his common stocks by their operating performance, not by their short-term (daily, weekly, monthly, yearly) temperamental price quotes. In the long run (years), he knows that if the operating performance of his business is superior, the market will, at some point, price the stock higher.” (68)
“The failure of most portfolio managers to exceed the major indices is not a reflection of intelligence, Buffett says, but a symptom of the institutional decisionmaking process. According to Buffett, most institutional decisions are made by groups or committees who possess a strong desire to conform to generally accepted portfolio safeguards. The institution that compensates the money manager equates safe with average. Adherence to standard diversification practices, rational or irrational, is rewarded over independent thinking.” (73)
“Whether purchasing a controlled or a non-controlled business, Buffett continually follows the same equity-investing strategy: He looks for companies he understands, with favorable long-term prospects, that are operated by honest and competent people and, importantly, are available at attractive prices. ‘When investing,’ he says, ‘we view ourselves as business analysts not as market analysts, not as macroeconomic analysts, and not even security analysts.’” (75)
“[Buffett says,] ‘An investor needs to do very few things right as long as he or she avoids big mistakes.’”(77)
“According to Buffett, the economic world is divided into a small group of franchises and a much larger group of commodity businesses, of which most are not worth purchasing. He defines a franchise as a company providing a product or service that is (1) needed or desired, (2) has no close substitute, and (3) is not regulated. These traits allow a franchise to regularly increase the prices of its product or service without fear of losing market share or unit volume. Often a franchise can raise its prices even when demand is flat and capacity is not fully utilized. This pricing flexibility is one of the defining characteristics of a franchise; it allows franchises to earn above-average returns on invested capital. Another defining characteristic is that franchises possess a greater amount of economic goodwill, which enables them to better withstand the effects of inflation....A franchise can survive inept management; a commodity business cannot.” (78-79)
“Growth and value investing are joined at the hip, says Buffett. Value is the discounted present value of an investment’s future cash flow; growth is simply a calculation used to determine value.” (95)
“[Buffett] is convinced that although the stock market, in the short run, may ignore a business’s financial results, it will, over time, confirm a company’s success or failure at providing increased shareholder value....Sometimes the market will quickly confirm Buffett’s judgment that a company is a good investment. When that happens, he is not compelled to sell just because of short-term appreciation. He considers the Wall Street maxim ‘you never go broke taking a profit’ to be foolish advice. Fisher taught him that either the investment you hold is a better investmen that cash or it is not. Buffett says that he is ‘quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.’ If the stock market does significantly overvalue a business, he will sell. In addition, Buffett will sell a fairly valued or undervalued security if he needs the proceeds to purchase something else....”
(99-100)
“The Warren Buffett Way
Step 1. Turn off the stock market.
Step 2. Don’t worry about the economy.
Step 3. Buy a business, not a stock.
Step 4. Manage a portfolio of businesses.” (256)
“Buffett’s Tenets
Business Tenets:
Is the business simple and understandable?
Does the business have a consistent operating history?
Does the business have favorable long-term prospects?
Management Tenets:
Is management rational?
Is management candid with its shareholders?
Does management resist the institutional imperative?
Financial Tenets:
Focus on return on equity, not earnings per share.
Calculate “owner earnings.”
Look for companies with high profit margins.
For every dollar retained, make sure the company has created at least one dollar of market value.
Market Tenets:
What is the value of the business?
Can the business be purchased at a significant discount to its value?” (260) |
