BUFFET’s Value Investing

Great Advice from Warren Buffett

Warren Buffett created Berkshire Hathaway (NYSE: BRK-B) and has been revered as a highly respected investor for a quarter of a century. Apparently his talent wasn’t truly apparent to the world until he gave a 1984 speech at Columbia University titled “The Superinvestors of Graham-and-Doddsville.” In a world with millions of investors, consistently profiting from stock market investing can not be attributed to luck. Mr. Buffett is one of nine “superinvestors”, whose record of successful investment decisions over decades is worth investigating. What is their secret? Well, their one common link is that all nine superinvestors hailed from the investment school of Benjamin Graham and David Dodd: Columbia professors now known as the fathers of value investing. This common link is huge. It meant that their success wasn’t the product of luck. It almost had to be attributable to the only common link they shared: the investing philosophy learned from Graham and Dodd. Mr. Buffett called it the “intellectual origin.”

In Buffett’s 1984 speech he spoke of the nine “superinvestors”, himself included. All nine have crushed the market averages over multiyear periods by between 8% and 22% per year

Mr. Buffett states the superinvestors’ core values quite succinctly: The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. It’s very important to understand that this group has assumed far less risk than average. While they differ greatly in style, these investors are always buying the business, not buying the stock.

Most investors aren’t superinvestors. To them, there’s little distinction between price and value. A cratering stock means risk, while a soaring stock somehow indicates strength and safety all with little regard to other, more deeply rooted factors. This is like assuming that all attractive people make great spouses. Risk appears when market value equals or exceeds the long-term value of a company’s discounted cash flows: its intrinsic value. It then diminishes in proportion to how far market price drops below intrinsic value.

The relationship between price and risk is often the opposite of what it’s comfortable to assume.

Here’s an example: Was Google (Nasdaq: GOOG) riskier in 2007, when optimism was on fire and shares exploded, or in late 2008, after shares crashed and bottomed out at around 12 times forward earnings? The answer is easy. Google was enormously risky in 2007, when the market assumed it was a surefire bet, and steadily approaching riskless territory in late 2008, when market volatility made investing look suicidal. Same goes for companies such as Alcoa (NYSE: AA) and Dow Chemical (NYSE: DOW). Investing risk was lowest when the performance and volatility of their shares looked bleakest. That was when the gap between price and intrinsic value was widest. That’s when you want to invest!

For medium to long term investors this is the kind of gap to look for. Presently a couple of candidates to consider are Western Union (NYSE: WU) and Wal-Mart (NYSE: WMT) as companies whose market price is far below their long-term intrinsic value.