Buying low, the Buffett way: tips to spot an investment star and avoid a damp squib
How do you separate shooting stars from damp squibs? Follow the lead of Warren Buffett: don't just buy a share because it looks cheap – buy an undervalued company that has a good business. That company, says Lourens Rabé of Seed Investments, could be doing ordinary things but it is doing them very well.
This is Lourens' latest piece in a series on how Buffett, probably the world's most admired investor, goes about identifying winning shares and avoiding stock market mistakes. Lourens reminds us that although Buffett has missed out on some of the most exciting stock market success stories, like Apple, the Sage of Omaha continues to produce average returns that outpace the markets. This is because he has stuck to his principle of only investing in companies he understands, and investing in them when market sentiment is against them. – JC
Value Investing the Buffett Way: 1987 – 1991
By Lourens Rabé
This is the third part in a series looking at Berkshire Hathaway's annual reports. In it, Warren Buffett continues to demonstrate his simplistic approach of looking at Berkshire's investment portfolio. Although asserting that the market is less attractive than the previous two decades, Berkshire's managers have produced extraordinary results by doing rather ordinary things – but doing them exceptionally well.
The best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago. Most sell non-sexy products or services in much the same manner as they did ten years ago (albeit in larger quantities, or at higher prices, or both). They may be making the most of an already strong business franchise, or concentrating on a single winning business theme.
Mr Buffett approaches a purchase as if it's a private business. He advises that when investing, one should view oneself as a business analyst (and not solely as a market, macroeconomic, or security analyst). He looks for outstanding businesses at a sensible price rather than mediocre businesses at a bargain price. Buffett concentrates his investments in a few companies that are understood well. He does not have in mind any time or price for sale, instead he's willing to hold a company indefinitely, granted that he expects the business to increase in intrinsic value at a satisfactory rate. He mentions that a stock is not necessarily an intelligent purchase purely because it is unpopular – i.e. being contrarian for the sake of it.
Mr Buffett states that declining share prices benefit investors, and rising prices hurt investors. "The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer." One should always be well positioned for prospective investments. "If you want to shoot rare, fast-moving elephants, you should always carry a loaded gun." During 1989 Mr Buffett increased his holdings in Coca Cola.
Mr Buffett is not weary of missing out on some company that depends upon an esoteric invention (Xerox), high-technology (Apple), or brilliant merchandising (Wal-Mart). Exotic sounding businesses that hold out the promise of feverish change generally trade at the highest PE ratios. That prospect lets investors fantasise about future profitability rather than facing today's business realities. Mr Buffett notes that, "We will never develop the competence to spot such businesses early. Instead I refer to business situations that Charlie and I can understand and that seem clearly attractive – but in which we nevertheless end up sucking our thumbs rather than buying."
A significant portion of Berkshires earnings were given to charity. During November 1988, Berkshire's shares listed on the New York Stock Exchange. Mr Buffett's wish was to attract long-term owners who, at the time of purchase, had no timetable or price target for sale but plan instead to stay with Berkshire indefinitely. Long term investors have been handsomely rewarded.
Footnote As Benjamin Graham once said: "Investment is most intelligent when it is most business-like." This is a principle that we at Seed practice whenever making investments on behalf of our clients, says Lourens – who graduated from the University of Stellenbosch at the end of 2009 with BCom (Law) and studied further to complete BCom (Investment Management) in 2011. In 2012, Lourens completed his BCom (Hons) in Financial Analysis and Portfolio Management at the University of Cape Town whilst working working as a junior investment analyst at Seed Investments.