When Warren Buffett purchased shares in The Washington Post Company (WPO), he showed us how to implement Benjamin Graham’s three key investment principles in real life investing. In other words, with this investment, Mr. Buffett showed us how to 1) think about a stock (i.e. as part-ownership in a business and not some ticker bouncing up and down), 2) think about market fluctuations (remember the Mr. Market parable), and 3) invest with a margin of safety.
“…The Washington Post Company (“WPC”) provides an excellent example.
We bought all of our WPC holdings in mid-1973 at a price of not more than one-fourth of the then per-share business value of the enterprise. Calculating the price/value ratio required no unusual insights. Most security analysts, media brokers, and media executives would have estimated WPC’s intrinsic business value at $400 to $500 million just as we did. And its $100 million stock market valuation was published daily for all to see. Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.
Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value - and even thought, itself – were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)
Through 1973 and 1974, WPC continued to do fine as a business, and intrinsic value grew. Nevertheless, by yearend 1974 our WPC holding showed a loss of about 25%, with market value at $8 million against our cost of $10.6 million. What we had thought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to well below 20 cents on the dollar of intrinsic value.
You know the happy outcome. Kay Graham, CEO of WPC, had the brains and courage to repurchase large quantities of stock for the company at those bargain prices, as well as the managerial skills necessary to dramatically increase business values. Meanwhile, investors began to recognize the exceptional economics of the business and the stock price moved closer to underlying value. Thus, we experienced a triple dip: the company’s business value soared upward, per-share business value increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value.
We hold all of the WPC shares we bought in 1973, except for those sold back to the company in 1985’s proportionate redemption. Proceeds from the redemption plus yearend market value of our holdings total $221 million.”
— 1985 Berkshire Hathaway Chairman’s Letter to Shareholders, Warren Buffett
So, Berkshire Hathaway (BRK.A)(BRK.B) invested $10.6 million into WPC in mid-1973, and by the end of 1985, investment proceeds and year-end market value of WPC holdings totaled $221 million. Thus, the company ended up with almost 21 times original cost on this investment (not bad for 12 and a half years).
How did this investment nirvana come about?
Buffett bought WPC at around one-quarter of then per-share intrinsic value while others were concerned with the price showing on the ticker and efficient market theory, etc.
By year-end 1974, Buffett was confronted with a 25% loss on his original investment. However, that didn’t faze him -- because the Washington Post Company (the business) was doing just fine.
Eventually, Buffett was vindicated. The “business value soared upward, per-share business value increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value.”
While few of us have made 20 times our money on an investment, we can all follow Buffett’s investment process. To do so, we must properly analyze business value, not get carried away with general market sentiment, and buy with a margin of safety. Then, of course, we need to have patience and wait for the market to recognize true business value. If we can follow these few simple steps, we should be able to improve our investment outcomes.