Warren Buffett is a legend among value investors, and for a good reason. His investment record is unmatched by any other investor who existed in the last 100 years. Value investors, understandably, have tried to emulate Buffett’s approach to investing in the hopes of snagging a sliver of his returns. This typically means being glued to CNBC in the hopes of catching an interview, pouring over a mountain of books written about him, or combing through Warren Buffett’s annual letters for nuggets of wisdom.
Unfortunately, trying to emulate Warren Buffett has led investors to adopt a less than ideal strategy.
In my experience, finding wonderful companies can be very hard as it involves a lot of intimate knowledge about the business and making educated assumptions about where the industry is heading.
For an individual investor to develop the kind of knowledge which Buffett employs to make investment decisions would take a lifetime, and all the while, his actual returns from investing will lag far behind the general market.
Even if you can find a wonderful company, it is even more challenging to find it at a great price. Over the past three decades, most of the investments made by Buffett have been in private companies where he can negotiate the price, unlike the stock market, where you get offered a price and you can either take it or leave it; there is no negotiating. Plus, the private companies are willing to sell to Buffett at a lower price because of being attached to the fame of Berkshire Hathaway and Buffett.
Don’t get me wrong, some of the most important concepts about investing have been introduced to me by the letters written by Warren Buffett over the past 50-60 years. They are some of the most critical reading material for someone who wants to become an investor; they teach you more about investing than any college course or book. But over the past 60 years, the way Buffett invests his money has radically changed.
Buffett spent his early years searching for net-net stocks, strictly adhering to the principles taught by the dean of value investing, Benjamin Graham. Buffett changed his investing style as the amount of capital he had grown to substantial amounts, and he could no longer buy the smaller ignored deep value companies because they had become too small for him to put even 5-10% of his capital into a single company.
Buffett was forced to switch from deep-value small companies to buying wonderful companies at great prices.
My point is to emulate the Warren Buffett, who had the same amount of money as you have right now, not the one with billions of dollars to invest.
He only changed his approach from deep-value to buying wonderful companies because he was forced to, not because it was a better alternative.
Joel Greenblatt is a world-class investor, as well. During his early career, he reportedly racked up returns even larger than Warren Buffett did during his partnership days by focusing on deep value and special situations. On page 49 of Greenblatt’s unfortunately titled book, “You Can Be A Stock Market Genius,” he writes, referring to Buffett’s contemporary investment strategy,
“The problem is that you’re not likely to be the next Buffett or Lynch. Investing in great businesses at good prices makes sense. Figuring out which are the great ones is the tough part. Monopoly newspapers and network broadcasters were once considered near-perfect businesses; then new forms of competition and the last recession brought those businesses a little bit closer to earth. The world is a complicated and competitive place. It is only getting more so. The challenges you face in choosing the few stellar businesses that will stand out in the future will be even harder than the ones faced by Buffett when he was building his fortune. Are you up to the task? Do you have to be?
Finding the next Wal-Mart, McDonald’s, or Gap is also a tough one. There are many more failures than successes.”
Even Buffett himself, when asked what he would do if he were managing small sums of money once again, his answer was very telling,
“The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today’s environment because information is easier to access.
You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map - way off the map. You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.
Other examples: Genesee Valley Gas, public utility trading at a P/E of 2, GEICO, Union Street Railway of New Bedford selling at $30 when $100/share is sitting in cash, high yield position in 2002. No one will tell you about these ideas, you have to find them.
The answer is still yes today that you can still earn extraordinary returns on smaller amounts of capital. For example, I wouldn’t have had to buy issue after issue of different high-yield bonds. Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.”
No insight is required on the quantitative side - the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions, but, in my opinion, the more sure money tends to be made on the obvious quantitative decisions.
Individual Investors would be far better off trying to find companies that are off the grid and where the numbers are too good to ignore, saving them a lot of time and helping them outperform the overall market.