**Long Post Follows**
>>>Twister, how about clarifying what Sandborn does if he does not use Graham's "bag"? <<
Sanborn (corrected spelling) tries to find good businesses that sell at 60% of the price that someone who knows the business intimately and wants to hold FOREVER, would pay for the whole thing. To calculate that, you do have to follow transactions or at least know what the current guidelines are. This investor pays particular attention to EBITA, that it operating earnings + amortization which is his proxy for owner's free cash flow. If he likes a business, he will then figure out what kind of multiple to put on this EBITA, while also taking the level of debt into account.
What does it take to invest this way? Well it takes about as much accounting knowledge as it takes to do Graham analysis but of course the more you know the better. It also takes some QUALITATIVE skills and some fundamental business knowledge, and the kind of knowledge that Lynch talks about in his books. But mostly, you should be RATIONAL. Buffet points out that most any investor could have determined that KO was a SPECIAL business. But at the time, the WS analysts had labeled the thing "avoid" "hold" or “market performer" because they did a basic P/E analysis and determined "this is too rich." Buffet on the other hand noticed that KO had been growing its international business rapidly, had sold Columbia, bought back stock, and reversed the "deworsification." He noticed that KO's moat was getting deeper and wider. He then said, this is something I want to hold forever and basically discounted the free cash flows from here to doomsday at the long bond rate and had a fantastic business with a HUGE MARGIN OF SAFETY on his hands. Well you know the rest. Now what SUPERHUMAN skills did this take? Buffet would say none. In fact, Buffet says there are plenty of investors who have more brainpower than he does (mostly in Greenwich) <G>. But he is totally RATIONAL about investing, as is Charlie Munger.
Getting back to Sanborn. Just in the interview I read, I Learned that defense companies tend to be bought by rational owners at 8 to 12 times EBITA and that even the 12 times EBITA ones work well for long term OWNERS. I also learned that good newspapers tend to be bought by RATIONAL owners who want to purchase the entire company and also plan to keep it forever, will pay 15 times EBITA. So now I can look at newspaper companies and defense stocks, all in one interview freely available to ANYONE. What did I do with this knowledge? Well I put two and two together. I remembered that Buffet still likes the Buffalo News and WPO. I also know what these companies are purchased for in transactions. I also know that ECP is Media Company that OWNS two monopoly newspapers. It took me a few minutes to determine that ECP would command a price somewhere north of $90 a share if it were sold. Since the intrinsic value of that company is growing at 8% to 10% rates, I figured it would be a safe investment at prices somewhere less than $60 which is where I was buying stock back in October down to $55. Now I don't know how this will all work out but I feel pretty sure that that's THE WAY the game is played, more or less by the "good business" bunch, of which there are MANY practitioners. Buffet has LOVINGLY repudiated Graham's teachings and made it safe for many so called “value” investors to invest LIKE WARREN, if not with him.
Paul, you may not like to hear this but Buffet is not the only one who has repudiated the original Graham doctrine. There is a long list of the most successful investors practicing today who also have turned away from Graham. Price, Sanborn, Gipson-Sandler, Longleaf, Sequoia, Miller of Legg Mason, Weitz, Yacktman, Davis, Posner, Train, and Baron. Can you name me some successful, well known investors who are practicing strict Grahamite methods?
Thought so. Why is that? Because, taking nothing away from Graham, who was an excellent teacher, the state the art has passed those teachings by. This is a good thing—learning. Let me add that, IMO, you aren't correct when you say that this way of investing "can't be practiced" by the typical investor. I believe your way has LESS practicality. Frictional costs are higher, and it is far less tax efficient. You must also make two careful transactions, the first to buy, then to sell.
Finally, let me leave you with something Bill Miller said in one of those "esoteric" interviews published on the WWW:
"The market is pretty efficient and simple-minded stock selection--buy low P/E, buy this, buy that--is highly unlikely to add a lot of value over time. At one time they could. When no one was buying low P/E stocks, you could make a lot of money doing that. You can't now."
Q:
So you wouldn't put much store in these historical studies, like O'Shaughnessy's or Dreman's, that show the success of low-P/E strategies in the past?
A:
"No, I do. Since the future hasn't happened yet, the past is the only thing you have to work with. But I think that when you look at those things you really have to be careful and put them in context. Let's see the context that gave rise to them. Let's see why it might have worked. Let's see if it makes sense with what we know about current finance theory. Let's get into it a little bit as opposed to saying "Gee, I have these correlations and they sure do look robust. Let's go invest this." It's like Buffett said, if all there was to investing was looking up the data and figuring out the data, the richest people in the world would be librarians."
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