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The Investment Checklist That Transformed Warren Buffett

February 28, 2012 | About:
Who says old dogs can’t learn new tricks? Who Says Elephant Can’t Dance?

Not Warren Buffett. Not IBM (IBM). But how does an 82-year-old bargain hunter learn new tricks of buying tech stocks at new high prices and predicting future tech trends? Well, he read a corporate turnaround playbook written for IBMers. He read it not just once, but twice!

The book, "Who Says Elephants Can't Dance?: Leading a Great Enterprise through Dramatic Change," was written by Louis V. Gerstner Jr., former IBM CEO, the man who masterminded the historic turnaround of Big Blue. I have to admit that it is one of the best business books I have ever read, with penetrating insights on turnaround, strategy and culture. I highly recommend it to anyone interested in business and management. It is a must-read case study for deep-value investors interested in turnaround situations.

The investment checklist that changed Warren Buffett

Over the years, we have reverse-engineered almost all of Mr. Buffett’s investment decisions in the past, and we have never seen him buying into a growth-oriented tech stock at prices near all time highs after a substantial rally. What has turned a bargain-hunting value investor into a growth-minded tech buyer?

An investment checklist from Lou Gerstner’s IBM playbook could provide important clues to Buffett’s change of heart.

If Gerstner, the man who saved IBM, were the head of research at a securities firm, he would urge his analysts to focus on the following five points in determining shareholder value:

1. LEADING A GROWING MARKET: Is the company a major force in a growing market or market segments? (Remember Warren Buffett's wonderful observation: “When a manager with a great reputation meets a company with a bad reputation, it is the company whose reputation stays intact.”)

2. INCREASING MARKET SHARE: Is the company holding or increasing its share in those segments, and is that share gain the result of sustainable advantages (cost, technology, quality)?

3. GENERATING CASH: Is the increased share resulting in growing cash flow — cash flow after all expenses, not the notorious EBITDA (earnings before interest, taxes, depreciation and amortization), and not pro forma nonsense?

4. INVESTING CASH WISELY: Is the company using that cash flow in a wise manner? (a) avoiding macho or bleary-eyed acquisitions; (b) reinvesting in research and development, marketing and other critical areas in the company.

5. ACTING LIKE OWNERS: Does the management team walk the talk of aligning with the shareholders? Do executives own significant amounts of stock (as opposed to just holding options)? Do they return cash to their shareholders in the form of dividends or share repurchases?

IBM’s framework for growth

Gerstner’s handpicked successor, Samuel J. Palmisano, says his guiding framework for capital decisions boils down to four questions:

1. “Why would someone spend their money with you — so what is unique about you?”

2. “Why would somebody work for you?”

3. “Why would society allow you to operate in their defined geography — their country?”

4. “And why would somebody invest their money with you?”

The four questions were a way to focus thinking, prod the company beyond its comfort zone and make IBM preeminent again. “The hardest thing is answering those four questions,” Palmisano says. “You’ve got to answer all four and work at answering all four to really execute with excellence.”

On IBM’s decision to move out of the PC business, he said, “If you decide you’re going to move to a different space, where there’s innovation and therefore you can do unique things and get some premium for that, the PC business wasn’t going to be it.”

The divestitures meant that IBM was no longer the world’s largest information technology company. Hewlett-Packard (HPQ) took that title and took a different strategic path as well, doubling its bet on PCs by acquiring Compaq in 2001. “You see the choice that was made, and how the economics worked out,” Palmisano observes.

The idea, Mr. Palmisano explains, is to go to a space where you’re uniquely positioned and use your strengths.

In recent years, Warren Buffett's investment style seems to be moving from value to growth. And IBM’s playbook played an important role in his venture into tech and growth.

Disclosure: The author owns shares of Berkshire Hathaway.

About the author:

Dr. Zen
Brian Zen, CFA, PhD, author of "Superinvestor Lecture Notes", serves as Chief Investment Strategist at Zenway Group, a New York-based registered investment advisory firm providing asset management services, training Certified Securities Appraisers (CSA), and teaching Graham-Buffett Value Investing. Previously, Brian served as vice president at JPMorgan Chase and portfolio manager at Prudential-Bache Securities and Janney Montgomery Scott, while teaching graduate-level investment analysis at St. John's University. Brian was a Bernard Baruch Fellow and graduated summa cum laude from Bernard M. Baruch College. He is also a graduate of Columbia University's executive program in value investing. Brian appreciates your feedback at: bzen@zenway.com

Visit Dr. Zen's Website


Rating: 3.4/5 (27 votes)

Comments

tonyg34
Tonyg34 - 2 years ago
I think that checklist is brilliant, its what all blue chip companies say they are doing
BrianZen
BrianZen premium member - 2 years ago
Hi, TonyG, I agree. Lou is a brilliant man whose simple words and incisive analysis can really get people excited. No wonder Warren read his playbook twice.
cyclop9
Cyclop9 - 2 years ago
This is the 1st article written by a PhD holder ;

1- that is clear, simple to understand and straight to the point. No need for a second reading. In this world where things are going so fast we can't afford to waste time.

2-the author has the reader in mind while writing the article instead trying to sound smart.

3-the article emphasized Return on Understanding over Return on Words

Conclusion: I'm saving that article and I will keep for the years to come!
cyclop9
Cyclop9 - 2 years ago
This is the 1st article written by a PhD holder ;

1- that is clear, simple to understand and straight to the point. No need for a second reading. In this world where things are going so fast we can't afford to waste time.

2-the author has the reader in mind while writing the article instead trying to sound smart.

3-the article emphasized Return on Understanding over Return on Words

Conclusion: I'm saving that article and I will keep for the years to come!
SUPERINVESTOR.net
SUPERINVESTOR.net - 2 years ago
Some PhDs publish articles that make most of us scratch our heads. Academics make analysis as complex (and as "original") as possible. Practitioners make things as simple as possible and understandable so as to develop much needed conviction. You can't have conviction if the analysis has too many greek letters.
Steve Pomeranz
Steve Pomeranz premium member - 2 years ago
Take a look at Geoff Gannon's latest article on Buffetts IBM buy. It's an eye opener!

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