Empower Your Investing by Scott A. Chapman CFA

Author:Scott A. Chapman CFA [Chapman, Scott A.]
Language: eng
Format: epub
Publisher: Post Hill Press
Published: 2019-06-21T16:03:20+00:00

33 United States of America Financial Crisis Inquiry Commission Interview of Warren Buffett, May 26, 2010.

34 Dow Jones News, “Billionaire Buffett Takes a Swipe at Trust Fund Kids,” October 3, 2000.

CHAPTER 19

Evolution of Buffett’s Stock Selection Method

We’re adapting reasonably to a business that’s gotten very much more difficult.

—Charlie Munger1

The last chapter discussed the influences on Warren Buffett’s stock picking philosophy. This chapter explores the evolution of Buffett’s investing style. His investments followed three distinct phases:

1. Early Buffett: Mediocre smaller companies bought at bargain “cigar-butt” prices in the classic style of Benjamin Graham, which emphasized buying companies priced at a discount to tangible assets on the balance sheet. Graham had his limitations. In 1988 Buffett told Fortune magazine columnist Carol Loomis, “Boy, if I had listened only to Ben, would I ever be a lot poorer.” Buffett conceded at the 1996 Berkshire Hathaway annual meeting that one of his biggest mistakes was not paying up for quality businesses.

2. Later Buffett: Quality businesses, in the style of Charlie Munger, Phil Fisher, and Phil Carret, which were not selling at prices related to tangible assets, but were attractively priced relative to their future earnings power based on a qualitative assessment of the durability of a company’s competitive advantages. In Buffett’s terminology, he assessed whether the company’s “castle” was surrounded by a wide protective moat and whether the company’s product had pricing power. These companies typically generated high returns on capital (ROIC) and required little incremental capital to grow.

The principles of buying value and margin of safety and the detachment from the market I learned from Ben. You might say that I learned the proper temperamental set from Ben. The stocks I buy are entirely different from what Ben would buy if he were alive today.2

Buffett also believed that Ben Graham’s method wouldn’t scale with large sums of money at Berkshire.

During this period, Buffett evolved toward Charlie Munger’s influence of buying excellence; especially companies with strong brand loyalty and pricing power. Often these brands were much more valuable than their tangible assets, but the value of their intangible brand didn’t appear on their balance sheet. Graham relied on quantitative bargains based on tangible assets, and Buffett transitioned to quantitative bargains based on future cash flows. Graham had no interest in predicting earnings because he didn’t have confidence about those predictions. Unlike Buffett, Graham followed Yogi Berra’s advice that it is tough to make predictions, especially about the future. Fortunately, Buffett was a fan of another baseball hall of famer, Ted Williams, who advised to wait for the right pitch. Buffett said “we mostly buy stocks for future earnings3” and those stocks have to be a fat pitch. Otherwise, he will stand with the bat on his shoulder.

3. Modern Buffett: Large, capital-intensive companies with stable, recession-resistant returns in the mature Berkshire phase. Warren Buffett admitted that:

You can’t expect to get returns in the utility business (that you get in other businesses). It’s not a great business; it’s a good business. And the more money we can put in good businesses, the better I like it.

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