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LEARNING FROM A LEGEND:HOW WARREN MADE HIS BILLIONS

INTRODUCTIONI was looking at Inco – a nickel-mining company – about a year ago. It had
outstanding numbers, including a low price-to-earnings ratio (P/E), big
margins, and a good cash flow. So – after doing my research into the
company’s growth strategy and management team – I recommended it to
my subscribers.
It’s now up over 80%.
What did I know that other investors missed?
It’s pretty simple. I knew that mining companies are sometimes discounted
because their industry is so cyclical. What’s more, the price of the
commodities they extract can also be volatile. I figured if this company
could somehow remove the question marks raised by those two issues, its
discounted price would have to rise.
When I found out that nickel was in serious short supply (a situation that
wasn’t going away anytime soon), I realized that Inco was in a strong
growth market that would also prop up nickel prices into the foreseeable
future. Then I looked very carefully at the company’s balance and income
sheets, its recent financial reports, production costs, capital expenditures,
and current and planned mine development activity. I liked what I saw.
I also concluded that its management team was strong … and that was all I
needed to know.
I concluded it was only a matter of time before this company’s stock would
rise – and if it didn’t happen right away, it would happen sooner or later.
As it happened, Inco went up later rather than sooner …
…which was no big deal. Sticking with the company didn’t take blind faith
or nerves of steel. I knew its fundamentals were real. It wasn’t hard for me
to sit tight, because I understood that with value companies … with beaten
down companies … with unpopular companies … it sometimes takes Wall
Street longer to recognize the same value in a company that you saw.
But, most of all, I had confidence in the course I was taking, because I was
following Warren Buffett’s investing philosophy.
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Three Simple Secrets to His Success
Why would I want to invest like Buffett? Try $34 billion. That’s how much
he’s worth.
And while other multi-billionaires have gained their riches through the
ownership of companies or through leveraged investments like derivatives
trading, he’s has gotten his through the stock market … through investing
in companies available to the likes of you and me … and then by simply
sitting on his investments.
Sure, he makes bigger investments than we can. But, if anything, that
limits the universe of companies he can invest in. With our more limited
funds, we have thousands of companies to invest in. He is limited to
hundreds.
Yet, that doesn’t seem to have held him back. A $10,000 investment in his
company (Berkshire Hathaway) in 1965 wound up being worth nearly $30
million by 2005. In contrast, $10,000 invested in the S&P 500 would have
risen to roughly $500,000.
If he can find companies that have earned him a fortune over time, what’s
our excuse?
The simple truth is, if you want to invest like Warren Buffett, you can.
What’s the secret of his success?
• He’s not afraid to invest in unpopular or unfashionable companies. In
fact, he seeks them out. These are typically the stocks that are the
greatest values.
Benjamin Graham – author of The Intelligent Investor (the classic
book on value investing) and Warren’s professor, mentor, and boss –
called them “cigar butt” companies. No longer of interest to the
market, and thus undervalued, but still with a few puffs of life in
them.
• From a distance, it appears that Warren must have the magic touch.
But, believe me, magic has nothing to do with it. He’s known for his
exhaustive research into companies.
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• He has to be excited about the company. I’m talking about the
company itself and the business it’s in – not the potential returns. My
friend and investment expert Porter Stansberry once told me, “You
can’t like a company in theory. You should be willing to give up your
first-born to run a company you’ve been checking out.”
That’s the way Warren sees it. In a recent Berkshire annual report,
he said, “Whenever we buy common stocks … we approach the
transaction as if we were buying into a private business.” In other
words, he looks at a company as if he’s going to partner up with it.
The Man With a Simple Plan That Made Billions
Born and bred in the Midwest, Warren Buffett is known as the Sage of
Omaha – nicknamed for that rather unremarkable Nebraska city on the
banks of the Missouri river.
He is a gray-haired, no-nonsense Man of the Heartland, who dared on
several occasions to not follow the Wall Street crowd into trendy
investments that ultimately proved disappointing. He became a legend,
admired for his simplicity and unpretentiousness, investing acumen, and
the billions of dollars he amassed.
As a result, his company’s annual meeting has become something of a
pilgrimage. Every May, it attracts thousands (14,000 for the last one) to
Omaha to catch the Sage’s latest take on the “Buffet Way” and – by
contrast – the tomfoolery of Wall Street. Warren himself has called the
occasion the “Woodstock of capitalism.” Some people buy a Berkshire
Hathaway share (by no means an inexpensive proposition) just to be able
to attend.
For one of the richest men in the world, he lives quite modestly. He still
resides in the same gray stucco house he bought for $31,500 back in 1956,
and everyone in Omaha knows where it is.
Warren’s straightforward and commonsensical approach to investing has
given hope to millions of ordinary investors that at least some measure of
his success can be emulated.
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How to Shop for Value, Quality, and Growth
Warren doesn’t depend on algorithmic models, sophisticated software
programs that mine and manipulate data, or secret formulas. Far from it.
In many ways, he approaches investing the way we approach shopping for
a car. So let’s take a look at how we do that.
But before we do, I want to describe a commercial about insurance that
I’ve been hearing on the local radio these days. It starts out: “I just bought
a car. And I got a great price!”
“What model?” a second voice asks. “I don’t know,” the first voice answers.
“What manufacturer?” the second voice then asks. “I don’t know.”
“Is it new or used?”
“I don’t know.”
The point of the commercial is that it’s silly to buy a car without knowing
exactly what you’re getting for your money – and it’s just as silly to buy
insurance that way.
You could say the exact same thing about buying stock.
We all know that before we dish out more than a few grand for a car, we
need to figure out if we’re getting a good price. It’s all about the car. How
does it perform? How often does it need repairs? What’s its resale value
going to be? These questions can readily be answered only if our particular
model has been in production for several years.
That’s fine with us, because we wouldn’t want a first-year model anyway.
Besides coming with no information as to how they might perform over
time, first-year models are never completely debugged.
If we wanted a good car at a good price, we also wouldn’t choose the most
popular model (which would probably be going for a premium). We’d
choose a slightly out-of-favor model. If we really wanted to save money,
we’d choose a car everybody hates.
And, being the cautious buyers we are, we’d look only for a car from a
manufacturer with a reputation for making quality vehicles that last. If we
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play our cards right, we’ll get the first two years of the car practically for
free. But we’ll need to get a great price on the car to be able to sell it two
years later for only slightly less than we paid.
If this is how you buy a car, you’re well on your way to understanding
several of the factors Warren considers when investing. Let’s start by going
over the factors touched upon in the above car-buying example. Then we’ll
address a few more.
Buying Quality
A car is only as good as the manufacturer that makes it, and a company is
only as good as the people who run it. Apart from good management,
you’d want quality products and services and a company you understand.
Let’s take these one at a time.
• Management. Warren puts strong management on the top of his
list. He likes to meet them in person and get to know them. That’s a
little too much to ask of you. But, at minimum, you should read the
CEO’s bio (which is typically provided on a company’s website).
And google the CEO’s name. Nine times out of 10, you’ll get plenty of
instant reading material. If you can, go to the company’s annual
meetings and listen to the CEO and other executives speak. Or – if
that’s not possible – listen to their called-in quarterly earnings report.
Just remember that there’s no such thing as too much direct and upclose
exposure to the companies you’re investing in. The more you
know about them, the better buy/sell decisions you will make.
• Quality products. As a general rule, the more high-end its products
are, the better margins a company makes. Companies charge a
premium for new technology, sleeker designs, more features, better
packaging – which all go into high-end products … and customers
gladly pay. The less high-end, the easier it is for China and other
countries to make cheap copies and put your company out of
business. ‘Nuf said.
• Understand the company. What does this have to do with quality?
Not much. But it has everything to do with your ability to judge
whether a company is in a class by itself or classless.
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You need to know at least something about the business. This is a
relative requirement, because this kind of knowledge often falls
somewhere between knowing nothing and knowing it all. But if you
don’t have a clue about what makes a company’s business tick, STAY
away. Whether or not a company can grow its profits should not be a
guessing game.
Nor should it be a “follow the leader” game. Even if everybody in
your bridge club is flocking to this business or a company in this
business, still STAY AWAY. Who knows what they’re following or
why? Bad advice is the ruination of many an investor.
Is looking into all this really necessary? Can so many people get it wrong?
Warren, in fact, counts on so many people not getting it. That’s why he
loves “cigar-butt” companies that are so out-of-favor nobody will touch
them.
He stays away from the buzz-generators. As a “life-long technophobe” (as
he confesses on the Berkshire website), he stayed away from the high-tech
companies when they were the rage in the 1990s.
How dare he?
“Warren Buffett should say ‘I’m sorry,’” fumed Harry Newton, publisher of
Technology Investor Magazine, in early 2000. “How did he miss the silicon,
wireless, DSL, cable, and biotech revolutions?”
That was the year AOL stock rose six-fold and Amazon.com had rocketed
by 1,000%, while shares in Berkshire had climbed only 11%.
But, as history proved, the “Buffett Way” won out in the end. The dot-com
bubble exploded, leaving millions of Americans poor and in shock.
Buying Discount
As the radio commercial above not-so-subtly points out, you have to know
something about a company and/or product before you even look at the
price. Lousy companies will be priced low because low quality fetches low
prices. You want good companies at low prices. Now that you know
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something about what makes a good company, let’s see what makes a
good price.
One of the most commonly used metrics is the price-to-earnings ratio, or
P/E. You can find the P/E on most financial websites that cover individual
companies. P/E refers to price per share over earnings (also known as net
income) per share.
Any company with a P/E below 10 is worth looking into. But P/E isn’t the
end-all be-all of judging a company’s price. First of all, you have to be sure
of what the P/E signifies. Usually, price refers to the current price and
earnings refer to the earnings of the company in the past 12 months.
Sometimes this will be called a “trailing” P/E.
The problem with a trailing P/E is that it’s backward-looking. It’s also worth
it to look up a company’s future (or forward) P/E or its price compared to
projected earnings over the next 12 months. If earnings (the denominator)
are going up, the P/E ratio will be going down compared to its trailing P/E.
That’s what you like to see.
Another way to get a peek into the future prospects of a company is by
looking at its PEG or price-to-earnings-to-growth ratio. Anything under 1 is
great, although staring at a 1.1 or 1.2 isn’t going to steer me away from a
company.
How does PEG work? Let’s say a company has a P/E of 12. And that
company has projected annual earnings over the next five years of 12%
per year. It would then have a 12:12 PEG ratio or a ratio of 1. If its
projected growth rate is 15% per year instead of 12%, its PEG ratio would
be less than 1. Companies would die for such a ratio … and here’s why.
A P/E of 12 is just okay. Remember, I just said that I like a P/E that’s
under 10. The S&P 500’s average ratio is about 18. So you could argue
that I’m being fussy. Darn right. I think the S&P 500 is way overpriced –
and it is, compared to its historical P/E average. I believe the S&P 500’s
overall P/E average is heading down, and I don’t want my companies to
have a good P/E only by today’s standards but by tomorrow’s also.
So we’re back to a P/E of 12 being just okay, and now you know why. On
the other hand, double-digit growth is better than okay. And I say that
even though companies have been reporting double-digit growth on
average for 16 quarters in a row.
THAT’S THE PAST, THOUGH.
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It’s going to become a lot more difficult to achieve double-digit growth in
the next five years than it was in the past five years. If investors love
double-digit growth and are willing to pay a premium for it now, just wait.
That premium is about to get a lot bigger.
I consider a company priced at a P/E of 12 (just over my cutoff point of 10)
as slightly overpriced – or, another way of saying it, that it’s going for a
slight premium over fair value. But if it also sports a PEG of 12:15 (an
impressive less-than-1), the small premium becomes justified and the
company goes from overpriced to fairly priced.
But the PEG’s strength is also its weakness. It’s great that it allows you to
peek into a company’s future, but it does so at the cost of becoming a little
speculative. Remember, the “G” part of PEG projects growth over a fiveyear
period. The PEG ratio is only as good as this projection. If the
company underperforms the “G” part of the PEG ratio, you’ve probably
hitched your wagon to the wrong star. Future P/E is less speculative, since
it only projects earnings 12 months out.
And it’s not only the “G” in PEG which muddies the waters. The “E” for
earnings is a fairly muddy category unto itself. It includes all kinds of
nonsense, such as tax write-offs, depreciation, one-time charges, and
sales. At the end of the day, it bears little resemblance to a company’s
actual operational earnings.
For these reasons, I like EBITDA (Earnings before Interest, Taxes,
Depreciation, and Amortization) much better – and I believe EV (enterprise
value) to EBITDA is a much better ratio than P/E.
EV is simply the market capitalization of a company plus its cash minus its
debt. It’s called “enterprise value” because that’s what you would pay for
the company if it were up for sale. The Yahoo financial Web page lists an
EV/EBITDA ratio for all the companies it covers. (Just click on the “key
statistics” link.)
In addition to P/E, PEG, and EV/EBITDA, there’s one more ratio you should
look at: price-to-book (P/B). The “book” refers to net assets or assets
minus liabilities. A P/B less than 1 either means you’re getting a great buy
on the company or its assets are worth as much as shares in Pan Am.
Think about it. At a P/B of 1, the price per share you’re paying is the same
as the value of the net assets per share. That means everything else you’re
getting with the company is free. The business – and the profits it
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generates – IS FREE. The future growth of the company? Free too. A P/B of
1 or less is a phenomenal ratio. But anything less than 2 is still considered
good.
This is what works for me. I first look at EV/EBITDA. Then I look at trailing
and future P/Es. And then I take in the PEG and P/B at about the same
time. The more ratios you throw at a company’s price, the better feel you
get for how much – if anything – it’s discounted.
Of course, it stands to reason that the riskier you think the company is, the
greater the discount should be.
Buying Safety
What kind of companies are least likely to tank and are most insulated
when the economy heads south? Companies going for a big discount …
companies with fat margins … and companies with wide moats. Let’s take
these things one at a time.
• Big Discounts. Warren’s mentor, Ben Graham, insisted on margins
of safety as the best way to protect investors against a loss.
We’ve already talked about the measurements to use in determining
whether a company is going for a good price. But just how good a
price should you go for?
Graham lived through the “Great Depression” of the 1930s. He
observed firsthand the stock market crash and its awful
consequences on shareholders who found themselves impoverished
practically overnight. Graham figured a discount or “margin of safety”
of at least 25% would be necessary to protect investors from such
future market shocks.
For Graham and Buffett, it’s not about the feel-good sensation of
getting a bargain. It’s more about getting real protection, and a
“margin of safety” accomplishes that to a certain degree.
Consider the following scenario.
Assume that a fairly valued market drops some 25% overall. It’s now
priced at 25% below fair value – the level at which you bought your
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stocks if you had followed Graham’s and Buffett’s lead. Because of
the built-in discount of your stocks, chances are they didn’t drop
nearly as much… and perhaps not at all.
If the market is overvalued, like it is today, a 25% drop would have
stopped short of the 25% discount you bought your stocks at. Your
stocks would still have room to move up to reach the overall
market’s level of valuation.
When the market is falling and you have a 25% margin of safety on
your stocks, one of two things is likely to happen.
Either your stocks will drop … but not nearly as far as the market.
Or, when the market bounces back, your stocks will be among the
first to recover.
Why? Other stocks may have been knocked down to their fair value
or just below. Their price is not so out of whack. But your stocks are
WAY BELOW their fair value. With a little good news or a little bullish
activity, they’re primed to bounce back up in a hurry.
And knowing this – that almost just as surely as water seeks its own
level, stocks seek their own fair price – why sell when your stocks
are down?
If you adopt the “Buffett Way” of investing, there’s no reason to. Mr.
Market is simply posting you the latest prices of your stocks, not
telling you to sell. That decision is entirely yours to make.
Warren is patient with his stocks. He picks them and holds them and
waits for the years to turn into decades. And it’s paid off for him. It’s
a package deal. If you pick ‘em like Buffett, you have to hold ‘em like
Buffett.
• Fat Margins. This is a favorite metric of Buffett’s, and a big favorite
of mine.
Margins tell you how much profit a company makes from its
revenues. Gross margins factor in very basic costs. Operational
margins factor in a host of additional costs to “operate” the business.
I look for operational margins of at least 15%. I go gaga over
operational margins of 25% (and gross margins of 50%).
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Big margins give a company a badly needed cushion when things go
awry – as they sometimes do with even the best of companies. It
could be the cost of raw materials going up or the price of their
products going down. Or a plant needing maintenance and shutting
down. Or an accounting “mistake.”
Some investors like to see margins improve from quarter to quarter,
or at least from year to year. That’s important if operational margins
are below 15%. It’s much less important for companies with margins
over 20%. Companies build up margins to give them a bigger share
of the profit and also to weather storms that will see margins fall,
though not to critically low levels.
In fact, some of the best buying opportunities come when investors
punish companies with margins that have fallen from – let’s say –
30% to 27%. If the other fundamentals look good, I scoop up these
stocks at their lower prices. But first, I make sure this isn’t the third
or fourth quarter in a row that margins have slid. I don’t want to
invest in a company with margins that are slowly but surely
deteriorating.
• Wide moats. How much distance can a company put between it and
its competitors by being a technology, brand, or marketing leader?
This is an easy concept to understand but a hard one to put it into
practice.
Intel probably thought it had a nice moat with its leading technology
and brand recognition. (A chipmaker marketing itself to consumers
was a first when they started to do it about a decade ago.) But Intel
found out that its moat didn’t protect it from serious market
encroachments by newcomer Advanced Micro Devices (AMD).
Ford and GM probably once thought their brand recognition gave
them a wide and deep moat over their obscure Japanese competition
like Honda (more known for motorcycles or lawnmowers than cars at
that time).
Sony once had a sizable moat. But between a problematic Playstation
3 launch and a few exploding batteries, its moat now isn’t nearly as
wide as it was not so long ago.
Moats are in the eye of the beholder. Recognize them when you see
them, but don’t take them for granted and don’t overestimate them.
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Remember, these companies probably have some very smart
competitors whose number one goal is to bridge those moats. You
have to decide for yourself just how effective a company’s moat is.
But this is what I’ve seen many times. When things go wrong for a
company, its moat dries up as the company wrestles with its
problems. And much of the protection it offered disappears fast.
There’s also another kind of moat – one that protects a company
from the downside of business and economic cycles.
Warren’s Berkshire Hathaway bought a utility last year. It bought
American Express 30 years ago. It also bought a beer company one
and a half years ago.
In addition, Berkshire owns GEICO and General Re – an insurance
and re-insurance company, respectively.
These companies all provide a substantial measure of protection
against a slowing economy.
They are very safe investments, because when the bears move in,
they are minimally affected.
This is very important, because investors typically lose half the gains
they made during a market bull in the following bear market. So if
you can avoid most of the adverse effects of a bear market, you’ll be
making about twice as much as other investors over time.
• Debt. Warren is partial to companies with little or no debt, and I
can’t blame him. Paying interest on loans lowers net earnings. And it
can add substantial uncertainty to a company’s risk profile.
If a company can’t pay its loans, that can be the beginning of a slide
into bankruptcy. But even if a company can pay off its loans, it can
find itself in serious trouble with the bank. It’s not just about the
money, but about the terms.
Banks can impose many conditions on loans – for instance, specifying
how much cash flow the company has to generate to meet its debt
and interest obligations. Such conditions are called covenants. And
they can make the CFO of a company go gray faster than Bill Clinton.
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Financially conservative companies expand by using their retained
earnings rather than getting bank loans. Or they issue shares. A
company’s debt-to-equity ratio (or D/E) can tell you how much debt
burden it has. (Equity is net assets plus retained earnings.) Debt
should be less than 50% of equity. A company’s total debt and
shareholder’s equity can be found on the balance sheet of a
company’s financial report.
For banks, real estate companies, and REITs (real estate investment
trusts), debt is unavoidable given the nature of these businesses, so
this metric can’t be used quite the same way.
Regardless of a company’s D/E, you should always delve into its
annual and/or quarterly reports and look up how well its loan
repayments are spaced out in future years. They’re never perfectly
even. And for those years when loans mature and become due, there
can be dramatic jumps in a company’s debt service burden.
A big jump can be a red flag, depending on when it is (the further
away, the better), the company’s ability to pay, and the lending
climate as the deadlines grow nearer.
• Cash Flow. Given his druthers, Warren likes companies that make
more than they spend. And he figures the less they spend, the more
they’ll make. And the more money that is left over after all the
spending and paying bills, the more gains there will be for
shareholders.
So you can cross capital-intensive businesses off his list. That is one
big hunk of the stock market that Warren could care less about. It’s
difficult for a company to generate cash that amounts to 10% or
more of its market capitalization.
But CF measures cash flow before capital expenditure. Free cash flow
measures CF after capital expenditure. Only companies with
extremely modest capital expenditure (capex) budgets can get their
free CF yield to average over 10%. But these are precisely the
companies that would most interest Warren.
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Buying Growth
In the music industry, they’re called one-hit wonders. I’m talking about
groups that had one big hit, and that’s it. Needless to say, they don’t make
a whole lot of money for themselves, their managers, or their record
companies.
Some companies are like that. They have a good year or two, and then it’s
downhill from there. Warren avoids these companies like the plague. How?
By not even taking a passing glance at these 1-year or 2-year wonders.
Warren is only interested in the 10-year (or more) wonders. He likes a 10-
year minimum track record of growth. Not because it proves a company
can continue to grow. The only thing it proves is that the company grew
during the past 10-year period. But if the company had the same
management then as it has now, they should know how to squeeze growth
out of the company going into the future.
Whether or not they can do it remains a big question. But it is a question
that a track record of length helps answer. Ten years of leaving its
footprints in a market can reveal a great deal about a company.
A Portfolio for the Ages
If you can buy quality, safety, and growth at a discount, Warren would no
doubt tell you to go for it. Buy that stock.
It certainly worked for him and his company. Shares of Berkshire hit the
landmark $100,000 mark in late October of 2006. They’ve come a long
way since March 10, 2000 when they hit a low of $41,300. That was the
same day the Nasdaq composite hit its high of 5048.62. Since then, the
Nasdaq is down 53%, while Berkshire is up 142%.
Berkshire’s portfolio of 38 stocks (worth $45.3 billion) was bought over a
long period, beginning in 1967. Shares of its “big four” companies –
American Express, Coca-Cola, Gillette, and Wells Fargo – started to be
acquired back in 1988.
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Of the 38 stocks, five are relatively new investments: Home Depot (HD),
Lexmark International (LXK), Tyco International (TYC), Anheuser-Busch
(BUD), and Kingfisher (KGFHY).
But don’t go rushing out to buy these five companies. The Budweiser stock,
for example, showed surprising weakness when Berkshire bought it and its
price has risen only slightly over Berkshire’s purchase price of roughly $45.
And scandal-ridden Tyco is still sorting out its mess. It’s a complicated
situation. I consider that investment to be too speculative at this point.
Nor is it going to do you much good if I list the remaining 30 stocks in the
Berkshire portfolio … except to satisfy your curiosity about which stocks are
in this top-performing portfolio.
Instead, you could invest in a mutual fund that mimics the investments
made by Berkshire Hathaway – the Wisdom Fund (WSDVX). It invests in
the 33 public stock holdings of the Berkshire portfolio. While it can’t invest
in those companies that Berkshire owns outright, it does the next best
thing. It invests in companies that share many of their same
characteristics.
The problem with this is that, for many companies in the portfolio, their
best growth days are behind them. It makes sense for Berkshire to keep
holding them as long as their shares don’t start to decline. But it makes
much less sense for you to buy these stocks across the board.
Of course, if you have $100,000 handy, you could buy a share of
Berkshire. If you can’t afford that modest sum, you can buy class “B”
shares for $3,333 per share.
BONUS! The Best Three of the 33 Buffet Stocks
Still, Buffet’s Berkshire portfolio – which has made him one of the richest
people in the world – includes some very enticing companies that deserve
a closer look. I’ve chosen three of the most impressive ones. They still
have outstanding value and growth potential. Here’s why I like them so
much:
• M&T Bank Corp. (MTB) Berkshire Hathaway owns 6,708,760
shares of this company – making it the second-largest institutional
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shareholder of this regional banking company. (It serves the
NY/DL/PA/MD/DC area.) Its P/E and price P/B are fairly average.
That makes M&T neither cheap nor expensive. But I like this bank
because it’s overcome shrinking earnings from net interest (the
difference between the interest of borrowing short and lending long)
by growing the loan and bank deposit side of its business. And it
keeps a tight lid on expenses. It’s still going strong with its earnings
per share growing rapidly. Bank executives also own a large piece of
this bank. Warren would approve.
• Mueller Industries (MLI) Mueller Industries makes refrigeration
valves, as well as copper, brass, aluminum, and plastic fittings and
shapes. Mueller recently started a manufacturing operation in China,
which will help keep costs down. And its recent purchase of Mexican
and UK companies will boost sales in those two key regions of the
world. Most important to its future profitability, Mueller has been able
to pass on rising raw material costs to its customers while still
expanding sales. And you can buy this stock at a nice discount. Its
P/E is under 10, less than half what the industry averages. And its
P/B is a third lower than the industry average.
• PetroChina Co. Ltd. (PTR) Can’t make up your mind whether to do
a China play or an oil play? Why not do both with this company?
Berkshire Hathaway owns a grand total of 0.37% of the shares of
this behemoth. That still comes out to a hefty $54,940,830
investment. What is Buffet getting for his money? A lot of capital
appreciation, for one. The stock climbed from $53 to $82 in 2005. It
hasn’t slowed down in 2006, and it’s not done growing. In a big,
growing, oil-starved country, PetroChina still remains a company with
lots of upside. And I love its margins – double the industry average.
There is one last thing you need to know about Warren: His investing
approach is much easier to understand than it is to follow.
First, he understands a lot of businesses. He knows the insurance business
from his days as a 21-year-old discussing GEICO with Ben Graham (who
was GEICO’s chairman at the time). He also knows how the manufacturing
business works. And he’s had a lot of experience in retail and banking.
Whatever kind of business it is that you know very well, Warren wants you
to stick to only that kind of business. That’s going to be hard to do,
because it’s going to narrow your choices dramatically. You can, however,
take comfort from Warren’s conviction that diversification is vastly
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overrated. If it’s just one business you know, that’s good enough in his
book.
Second of all, he’s super-careful and cautious in his investing approach. He
has shown on a number of occasions that if he can’t find good companies,
he’s more than willing to sit on his enormous pile of cash.
In doing so, he has to answer to shareholders who are looking for generous
returns on their investment in Berkshire. But you only have to answer to
yourself. That’s a lot easier. If Warren can do it, surely you can find the
discipline to not pull the trigger on companies that come up shy when
measured against the “Buffett Way.”
Third, he knows where to find the kind of companies he’s looking for. And
hey don’t grow on trees.
Most of the financial websites have search engines. Some have preset
“value” search engines where all you have to do is click on the “search”
link. Try out Yahoo/Finance’s “Bargain Growth” preset search
(http://screen.finance.yahoo.com/newscreener.html).
This screen searches for stocks with a PEG ratio less than or equal to 0.5
and total D/E ratios of less than or equal to 0.5. It also looks for earnings
growth estimates for the next five years that are greater than or equal to
25%.
There are other searches that you can customize yourself by putting in
your own criteria by P/E, CF, margins, etc.
In fact, I created a custom chart using all of Warren Buffett’s search
criteria, which you can access by clicking here
If you want to do it yourself, using the same Yahoo site as above, click on
“Launch Yahoo! Finance Stock Screener” and begin building your own. It’s
easy. This is all you have to do.
• For P/E, key in valuation, then “<=“ and then “12.”
• For forward P/E, key in valuation, then “<=“ and then “10.”
• For PEG, key in valuation, then “<=“ and then “1.”
• For Cash Flow, key in valuation, then EV/Operating CF, then “<=“
and then “10.”
• For Margins, key in Margins, then “operating margins,” then “>=“
and then “20.”
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• For Debt, key in Balance Sheet, then “total debt to equity,” then
“<=“ and then “.50.”
Ask for the top 25 companies, and then click on “run.”
Once the search engine spits out a list of companies, that’s when the
fun begins. Sometimes you get more than 25, and sometimes you get
fewer. When I last did a search like this, I got 19 companies.
Now you get to lay bare the companies’ strengths and weaknesses. It’s not
hard, but it does take a certain amount of time and effort. Their annual
reports are required reading – as are at least their last two quarterly
reports. And, of course, crunching the numbers, looking at them in
historical context, and projecting them into the future are all necessary
tasks.
After you’ve researched and qualified your list, you could end up with
anywhere between one and five “Buffett Way” companies to invest in.
Warren rarely veers off the path he’s trodden over and over through the
years with so much success. Put on your hiking boots. You’re next.
Welcome to the world of Warren Buffett.
Good Investing,