Now that I work for GuruFocus full-time, I write two newsletters. One is the Ben Graham Net-Net Newsletter. The other is the Buffett/Munger Bargains Newsletter. Both newsletters pick one stock per issue. Both newsletters come out once a month.
And both newsletters come out on a Friday.
Thereâs a reason for this. Itâs the same reason Warren Buffett releases his annual letter to shareholders on a Saturday morning. We want readers to have all weekend to digest the information before the stock market opens on Monday.
But thatâs where the similarities between the two newsletters end. These two newsletters pick very different stocks. Thatâs because they have very different strategies.
I think subscribers intuitively âgetâ the Ben Graham Net-Net Newsletterâs strategy. But, in case they donât â I put this description on the first page of every issue:
âA net current asset value bargain â or net-net â is a stock selling for less than the value of its current assets â cash, receivables, and inventory â minus all liabilities. Basically, itâs a stock selling for less than its liquidation value.â
Pretty simple concept, right?
I think so. And thatâs why I think it tends to be the newsletter folks are most interested in.
However, Iâm not sure thatâs the way it should be.
I love net-nets. I buy them myself. And I think investing in net-nets is the best way for a dedicated âdo-it-yourselfâ individual investor to beat the market. But that doesnât mean I think investing in net-nets is the best strategy for most investors â or even most GuruFocus Premium Members.
In fact, I donât. I think the strategy more people would be successful in applying to their own portfolios is the strategy followed by the Buffett/Munger Bargains Newsletter.
And what strategy is that?
In this monthâs issue of the Buffett-Munger Bargains Newsletter I tried to lay out the newsletterâs strategy as succinctly as possible:
1. Simple Business
2. Favorable Long-Term Prospects
3. Able and Honest Management
4. Consistent Earnings
5. Good Return on Equity
6. Little Debt
7. Very Attractive Price
Obviously, thatâs Warren Buffett talking. In fact, four of the Buffett-Munger Bargains Newsletterâs criteria are taken directly from Warren Buffettâs 1977 letter to shareholders:
âWe select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects,(3) operated by honest and competent people, and (4) available at a very attractive price.â
Because Buffett plainly said he picks his stocks the same way he picks his acquisitions â I also decided to add a few of Warren Buffettâs criteria for acquisitions:
¡ Consistent Earnings
¡ Good Return on Equity
¡ Little Debt
¡ Simple Business
These criteria come directly from Warren Buffettâs 1982 letter to shareholders:
âThis annual report is read by a varied audience, and it is possible that some members of that audience may be helpful to us in our acquisition program.
We prefer:
1. Large purchases (at least $5 million of after-tax earnings)
2. Demonstrated consistent earning power (future projections are of little interest to us, nor are âturn-aroundâ situations)
3. Businesses earning good returns on equity while employing little or no debt
4. Management in place (we canât supply it)
5. Simple businesses (if thereâs lots of technology, we wonât understand it)
6. An offering price (we donât want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).â
Some of those criteria donât really apply to common stocks. For example, a stock always comes with a manager in place and always comes with an offering price.
The issue of large purchases is an interesting one. Itâs relevant. But not in the way some people think.
Warren Buffett doesn't have a preference for big companies. He has a preference for big investments. The reason why he spent $10 billion buying IBM (IBM, Financial) stock is because he likes to put a big chunk of his portfolio into a single stock. He doesn't like spreading his bets across a couple dozen companies.
Because of Berkshire Hathaway's current size â big bets mean big companies. That wasn't always true. Berkshire bought plenty of small companies in the 1970s and 1980s.
Since GuruFocus Premium Members tend not to have multibillion portfolios â I don't see the point in limiting the Buffett/Munger Bargains Newsletter's stock picks to giant companies like IBM.
Actually, the Buffett/Munger Bargains Newsletter is modeled on the Buffett and Munger of the 1970s rather than the Buffett and Munger of today.
Here is what Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)'s portfolio looked like in 1977:
** In the 1977 letter to shareholders: GEICO is shown as two positions (common stock and convertible preferred) and Kaiser is shown as two positions (Kaiser Aluminum & Chemical and Kaiser Industries). In reality, Berkshire's position in GEICO was divided into those categories because of the way GEICO raised capital. And Berkshire's two Kaiser positions were the result of a spin-off. It was originally just one investment.
If the Buffett/Munger Bargains Newsletter wants to stay true to Warren Buffett's actual investment style â circa 1977 â what does it need to learn from that portfolio?
Well, for one thing, it needs to be focused. In 1977: Berkshire had over 75% of its portfolio in just 7 stocks. Even more interesting is Berkshire's 1977 portfolio by industry:
Media: 30%
Insurance: 24%
Advertising: 13%
Materials: 9%
Berkshire's top 7 stocks fall into just 4 industries. And two of those industries âmedia and advertising â are very similar. Insurance and Media/Advertising accounted for two-thirds of Berkshire Hathaway's 1977 portfolio.
That's some serious concentration. And it reflects Warren Buffett's interest in the long-term economics of an industry. Buffett believed the best insurers and the best media and advertising companies would be able to grow earnings while earning high returns on equity for a very long time.
This is where Warren Buffett's concept of a "moat" comes in.
Ten years after he constructed that 1977 portfolio â in 1987 â Warren Buffett wrote about a Fortune study of high return on equity companies:
"âŚOnly 25 of the 1,000 companies met two tests of economic excellence - an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%. These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500âŚThe Fortune champs may surprise you in two respects. First, most use very little leverage compared to their interest-paying capacity. Really good businesses usually don't need to borrow. Second, except for one company that is "high-tech" and several others that manufacture ethical drugs, the companies are in businesses that, on balance, seem rather mundane. Most sell non-sexy products or services in much the same manner as they did ten years agoâŚThe record of these 25 companies confirms that making the most of an already strong business franchise, or concentrating on a single winning business theme, is what usually produces exceptional economics."
The Buffett/Munger Bargains Newsletter incorporates Buffett's thinking on what produces "exception economics" in three ways:
1. We look for stocks with a high business predictability rank
2. We look for stocks with a high 10-year average return on equity
3. We look for stocks with low debt
In this month's issue of the Buffett/Munger Bargains Newsletter I added a "watchlist" of stocks that might be chosen in future issues.
This list of 5 stocks give you some idea of the kinds of companies the Buffett/Munger Bargains Newsletter likes to pick:
1. World Acceptance (WRLD, Financial)
2. Express Scripts (ESRX, Financial)
3. Walgreen (WAG, Financial)
4. Humana (HUM, Financial)
5. McDonald's (MCD, Financial)
Those are the kinds of companies a younger â and poorer â Warren Buffett might buy. Actually, a few of those companies are big enough for Warren Buffett to buy today.
The most important part of making any pick for the Buffett/Munger Newsletter is applying Warren Buffett's checklist:
1. Simple Business
2. Favorable Long-Term Prospects
3. Able and Honest Management
4. Consistent Earnings
5. Good Return on Equity
6. Little Debt
7. Very Attractive Price
You can't always get all 7.
Here's how this month's Buffett/Munger Bargains Newsletter's pick stacks up against Warren Buffett's checklist:
1. Highly technical "razor and blade" type manufacturing business
2. 10%+ sales growth. 70% of sales come from outside the U.S.
3. CEO is 30-year employee. Owns $200 million in company stock.
4. 5-star business predictability rank.
5. 10-year average return on equity: 40%.
6. More cash than debt.
7. P/E ratio of 19.
So, this month's pick meets 5 of Warren Buffett's 7 criteria perfectly. It's got: favorable long-term prospects, able and honest management, consistent earnings, a high return on equity, and little debt.
Where does it fall short?
Business simplicity and price.
The issue of business simplicity is a bit tricky with this company. It's a high-tech business. But it's a high-tech business I think Warren Buffett would be willing to buy. If that doesn't make any sense to you, you'll have to read this month's Buffett/Munger Bargains Newsletter to find out how that's possible.
This month's pick is obviously a wonderful company. Warren Buffett would love the company. But would he love the price?
I don't think so. Not the Warren Buffett of the 1970s. And that's the Warren Buffett the Buffett/Munger Bargains Newsletter is trying to emulate. The Warren Buffett of the 1970s wouldn't pay 19 times earnings for this company. Of course, stock prices were a lot lower in the 1970s than they are today.
So, would the Warren Buffett of today buy the Buffett Munger Bargains Newsletter's most recent pick at 19 times earnings?
That's hard to say. If it was big enough, he might. If the company we picked this month was the same size as IBM â it's not, IBM is 30 times bigger â Warren Buffett might very well buy it. Of course, if the company the newsletter picked was 30 times bigger â it wouldn't be growing as fast as it is.
But that probably tells us more about Warren Buffett's present predicament â having way too much cash to invest â than how well the Buffett/Munger Newsletter is approximating Warren Buffett's investment philosophy.
Part of the problem is interest rates. Buffett bought some companies in the 1980s that â when their valuations are adjusted for interest rates â may actually have been every bit as expensive as some wonderful companies are right now. But that assumes that when interest rates are low, stock prices should be high.
Is that right?
To a point. But it can be taken too far. Buffett has made it clear that he has no appetite for bonds right now. He thinks stocks are a better buy. He's probably right. But that raises the issue of whether today's interest rates are a good indicator of tomorrow's interest rates.
My answer to that question is simply â I don't know. You have three choices:
1. Use today's interest rates when considering valuations
2. Use long-term average interest rates when considering valuations
3. Use the higher of today's interest rates and long-term average interest rates when considering valuations
I think Warren Buffett prefers the third approach. He's more or less said that before. When U.S. Treasuries are yielding â say â 3%, he doesn't decide that a P/E of 30 is suddenly okay. But when U.S. Treasuries are yielding â say â 10%, he does decide that a P/E of 10 is starting to look reasonable.
So far, we haven't incorporated this kind of thinking into the Buffett-Munger Newsletter.
But â behind the scenes â GuruFocus is working on some interesting valuation techniques that do take interest rates into account. I hope to incorporate this thinking into the Buffett/Munger Bargains Newsletter in the months to come.
Once we do that, we'll be able to better mimic Warren Buffett's actual thinking when it comes to valuations: price matters, growth matters, and interest rates matter.
So, hopefully, we can move beyond using just the P/E ratio to describe the Buffett/Munger Bargain Newsletter's monthly picks.
Until then, I have to call it like I see it and say that this month's Buffett/Munger Bargain Newsletter's pick is a great company at an attractive price. Certainly not a very attractive price.
If you're the kind of investor who can't imagine paying 19 time earnings for any company â you probably want to check out the Ben Graham Net-Net Newsletter instead.
But if it's "good companies at fair or undervalued prices" you're looking for â the Buffett/Munger Bargains Newsletter is the newsletter for you.
Ask Geoff a Question about the Buffett/Munger Bargains Newsletter
Check out the Buffett-Munger Bargains Newsletter
Check out the Ben Graham Net-Net Newsletter
And both newsletters come out on a Friday.
Thereâs a reason for this. Itâs the same reason Warren Buffett releases his annual letter to shareholders on a Saturday morning. We want readers to have all weekend to digest the information before the stock market opens on Monday.
But thatâs where the similarities between the two newsletters end. These two newsletters pick very different stocks. Thatâs because they have very different strategies.
I think subscribers intuitively âgetâ the Ben Graham Net-Net Newsletterâs strategy. But, in case they donât â I put this description on the first page of every issue:
âA net current asset value bargain â or net-net â is a stock selling for less than the value of its current assets â cash, receivables, and inventory â minus all liabilities. Basically, itâs a stock selling for less than its liquidation value.â
Pretty simple concept, right?
I think so. And thatâs why I think it tends to be the newsletter folks are most interested in.
However, Iâm not sure thatâs the way it should be.
I love net-nets. I buy them myself. And I think investing in net-nets is the best way for a dedicated âdo-it-yourselfâ individual investor to beat the market. But that doesnât mean I think investing in net-nets is the best strategy for most investors â or even most GuruFocus Premium Members.
In fact, I donât. I think the strategy more people would be successful in applying to their own portfolios is the strategy followed by the Buffett/Munger Bargains Newsletter.
And what strategy is that?
In this monthâs issue of the Buffett-Munger Bargains Newsletter I tried to lay out the newsletterâs strategy as succinctly as possible:
1. Simple Business
2. Favorable Long-Term Prospects
3. Able and Honest Management
4. Consistent Earnings
5. Good Return on Equity
6. Little Debt
7. Very Attractive Price
Obviously, thatâs Warren Buffett talking. In fact, four of the Buffett-Munger Bargains Newsletterâs criteria are taken directly from Warren Buffettâs 1977 letter to shareholders:
âWe select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects,(3) operated by honest and competent people, and (4) available at a very attractive price.â
Because Buffett plainly said he picks his stocks the same way he picks his acquisitions â I also decided to add a few of Warren Buffettâs criteria for acquisitions:
¡ Consistent Earnings
¡ Good Return on Equity
¡ Little Debt
¡ Simple Business
These criteria come directly from Warren Buffettâs 1982 letter to shareholders:
âThis annual report is read by a varied audience, and it is possible that some members of that audience may be helpful to us in our acquisition program.
We prefer:
1. Large purchases (at least $5 million of after-tax earnings)
2. Demonstrated consistent earning power (future projections are of little interest to us, nor are âturn-aroundâ situations)
3. Businesses earning good returns on equity while employing little or no debt
4. Management in place (we canât supply it)
5. Simple businesses (if thereâs lots of technology, we wonât understand it)
6. An offering price (we donât want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).â
Some of those criteria donât really apply to common stocks. For example, a stock always comes with a manager in place and always comes with an offering price.
The issue of large purchases is an interesting one. Itâs relevant. But not in the way some people think.
Warren Buffett doesn't have a preference for big companies. He has a preference for big investments. The reason why he spent $10 billion buying IBM (IBM, Financial) stock is because he likes to put a big chunk of his portfolio into a single stock. He doesn't like spreading his bets across a couple dozen companies.
Because of Berkshire Hathaway's current size â big bets mean big companies. That wasn't always true. Berkshire bought plenty of small companies in the 1970s and 1980s.
Since GuruFocus Premium Members tend not to have multibillion portfolios â I don't see the point in limiting the Buffett/Munger Bargains Newsletter's stock picks to giant companies like IBM.
Actually, the Buffett/Munger Bargains Newsletter is modeled on the Buffett and Munger of the 1970s rather than the Buffett and Munger of today.
Here is what Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)'s portfolio looked like in 1977:
| Company | Percent of Total Portfolio |
| GEICO** | 24% |
| The Washington Post | 18% |
| Interpublic | 9% |
| Kaiser Aluminum** | 9% |
| Capital Cities | 7% |
| Knight-Ridder | 5% |
| Ogilvy & Mather | 4% |
| Total 7 Positions | 76% |
** In the 1977 letter to shareholders: GEICO is shown as two positions (common stock and convertible preferred) and Kaiser is shown as two positions (Kaiser Aluminum & Chemical and Kaiser Industries). In reality, Berkshire's position in GEICO was divided into those categories because of the way GEICO raised capital. And Berkshire's two Kaiser positions were the result of a spin-off. It was originally just one investment.
If the Buffett/Munger Bargains Newsletter wants to stay true to Warren Buffett's actual investment style â circa 1977 â what does it need to learn from that portfolio?
Well, for one thing, it needs to be focused. In 1977: Berkshire had over 75% of its portfolio in just 7 stocks. Even more interesting is Berkshire's 1977 portfolio by industry:
Media: 30%
Insurance: 24%
Advertising: 13%
Materials: 9%
Berkshire's top 7 stocks fall into just 4 industries. And two of those industries âmedia and advertising â are very similar. Insurance and Media/Advertising accounted for two-thirds of Berkshire Hathaway's 1977 portfolio.
That's some serious concentration. And it reflects Warren Buffett's interest in the long-term economics of an industry. Buffett believed the best insurers and the best media and advertising companies would be able to grow earnings while earning high returns on equity for a very long time.
This is where Warren Buffett's concept of a "moat" comes in.
Ten years after he constructed that 1977 portfolio â in 1987 â Warren Buffett wrote about a Fortune study of high return on equity companies:
"âŚOnly 25 of the 1,000 companies met two tests of economic excellence - an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%. These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500âŚThe Fortune champs may surprise you in two respects. First, most use very little leverage compared to their interest-paying capacity. Really good businesses usually don't need to borrow. Second, except for one company that is "high-tech" and several others that manufacture ethical drugs, the companies are in businesses that, on balance, seem rather mundane. Most sell non-sexy products or services in much the same manner as they did ten years agoâŚThe record of these 25 companies confirms that making the most of an already strong business franchise, or concentrating on a single winning business theme, is what usually produces exceptional economics."
The Buffett/Munger Bargains Newsletter incorporates Buffett's thinking on what produces "exception economics" in three ways:
1. We look for stocks with a high business predictability rank
2. We look for stocks with a high 10-year average return on equity
3. We look for stocks with low debt
In this month's issue of the Buffett/Munger Bargains Newsletter I added a "watchlist" of stocks that might be chosen in future issues.
This list of 5 stocks give you some idea of the kinds of companies the Buffett/Munger Bargains Newsletter likes to pick:
1. World Acceptance (WRLD, Financial)
2. Express Scripts (ESRX, Financial)
3. Walgreen (WAG, Financial)
4. Humana (HUM, Financial)
5. McDonald's (MCD, Financial)
Those are the kinds of companies a younger â and poorer â Warren Buffett might buy. Actually, a few of those companies are big enough for Warren Buffett to buy today.
The most important part of making any pick for the Buffett/Munger Newsletter is applying Warren Buffett's checklist:
1. Simple Business
2. Favorable Long-Term Prospects
3. Able and Honest Management
4. Consistent Earnings
5. Good Return on Equity
6. Little Debt
7. Very Attractive Price
You can't always get all 7.
Here's how this month's Buffett/Munger Bargains Newsletter's pick stacks up against Warren Buffett's checklist:
1. Highly technical "razor and blade" type manufacturing business
2. 10%+ sales growth. 70% of sales come from outside the U.S.
3. CEO is 30-year employee. Owns $200 million in company stock.
4. 5-star business predictability rank.
5. 10-year average return on equity: 40%.
6. More cash than debt.
7. P/E ratio of 19.
So, this month's pick meets 5 of Warren Buffett's 7 criteria perfectly. It's got: favorable long-term prospects, able and honest management, consistent earnings, a high return on equity, and little debt.
Where does it fall short?
Business simplicity and price.
The issue of business simplicity is a bit tricky with this company. It's a high-tech business. But it's a high-tech business I think Warren Buffett would be willing to buy. If that doesn't make any sense to you, you'll have to read this month's Buffett/Munger Bargains Newsletter to find out how that's possible.
This month's pick is obviously a wonderful company. Warren Buffett would love the company. But would he love the price?
I don't think so. Not the Warren Buffett of the 1970s. And that's the Warren Buffett the Buffett/Munger Bargains Newsletter is trying to emulate. The Warren Buffett of the 1970s wouldn't pay 19 times earnings for this company. Of course, stock prices were a lot lower in the 1970s than they are today.
So, would the Warren Buffett of today buy the Buffett Munger Bargains Newsletter's most recent pick at 19 times earnings?
That's hard to say. If it was big enough, he might. If the company we picked this month was the same size as IBM â it's not, IBM is 30 times bigger â Warren Buffett might very well buy it. Of course, if the company the newsletter picked was 30 times bigger â it wouldn't be growing as fast as it is.
But that probably tells us more about Warren Buffett's present predicament â having way too much cash to invest â than how well the Buffett/Munger Newsletter is approximating Warren Buffett's investment philosophy.
Part of the problem is interest rates. Buffett bought some companies in the 1980s that â when their valuations are adjusted for interest rates â may actually have been every bit as expensive as some wonderful companies are right now. But that assumes that when interest rates are low, stock prices should be high.
Is that right?
To a point. But it can be taken too far. Buffett has made it clear that he has no appetite for bonds right now. He thinks stocks are a better buy. He's probably right. But that raises the issue of whether today's interest rates are a good indicator of tomorrow's interest rates.
My answer to that question is simply â I don't know. You have three choices:
1. Use today's interest rates when considering valuations
2. Use long-term average interest rates when considering valuations
3. Use the higher of today's interest rates and long-term average interest rates when considering valuations
I think Warren Buffett prefers the third approach. He's more or less said that before. When U.S. Treasuries are yielding â say â 3%, he doesn't decide that a P/E of 30 is suddenly okay. But when U.S. Treasuries are yielding â say â 10%, he does decide that a P/E of 10 is starting to look reasonable.
So far, we haven't incorporated this kind of thinking into the Buffett-Munger Newsletter.
But â behind the scenes â GuruFocus is working on some interesting valuation techniques that do take interest rates into account. I hope to incorporate this thinking into the Buffett/Munger Bargains Newsletter in the months to come.
Once we do that, we'll be able to better mimic Warren Buffett's actual thinking when it comes to valuations: price matters, growth matters, and interest rates matter.
So, hopefully, we can move beyond using just the P/E ratio to describe the Buffett/Munger Bargain Newsletter's monthly picks.
Until then, I have to call it like I see it and say that this month's Buffett/Munger Bargain Newsletter's pick is a great company at an attractive price. Certainly not a very attractive price.
If you're the kind of investor who can't imagine paying 19 time earnings for any company â you probably want to check out the Ben Graham Net-Net Newsletter instead.
But if it's "good companies at fair or undervalued prices" you're looking for â the Buffett/Munger Bargains Newsletter is the newsletter for you.
Ask Geoff a Question about the Buffett/Munger Bargains Newsletter
Check out the Buffett-Munger Bargains Newsletter
Check out the Ben Graham Net-Net Newsletter
