As value managers, we are very focused on risk, so I really like the quote from Warren Buffett’s letter this year to the shareholders at Berkshire Hathaway. Warren said, “a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero.” Warren also says that there are just two important rules in investing: Number 1, don’t lose money; number 2, don’t forget rule number 1. Value investors as a group are usually pretty good at avoiding unnecessary risk. But academics will tell you that if you take less risk, you are doomed to earning below average returns. At Oakmark, we attempt to defy academic theory by focusing on three criteria that we believe simultaneously increase returns while decreasing risk.
The first hurdle is we only buy businesses when we believe they are selling at a significant discount to business value. We define business value as the maximum price a cash buyer could pay to acquire the entire business and still earn an adequate return on their investment. We want to purchase stocks selling—at most—at two-thirds of that number.
Our second goal is to buy businesses whose values grow with time. We don’t want to own structurally disadvantaged companies just because they’re cheap. Rather, we want our businesses to have a combination of per-share value growth and dividend yield that at least matches what we expect from average companies.
Our third requirement is we want managements that treat their shareholders like partners. That means having the economic incentives that make management act like owners. We like them to own a lot of stock. We like them to have reasonable options positions. And, we like them to have performance bonuses tied to measures that drive share value. But it is more than just economics. We also want managers that communicate with us like they would to their business partners. Timely, honest assessment of business performance, to us, is an entitlement of being a shareholder.
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The first hurdle is we only buy businesses when we believe they are selling at a significant discount to business value. We define business value as the maximum price a cash buyer could pay to acquire the entire business and still earn an adequate return on their investment. We want to purchase stocks selling—at most—at two-thirds of that number.
Our second goal is to buy businesses whose values grow with time. We don’t want to own structurally disadvantaged companies just because they’re cheap. Rather, we want our businesses to have a combination of per-share value growth and dividend yield that at least matches what we expect from average companies.
Our third requirement is we want managements that treat their shareholders like partners. That means having the economic incentives that make management act like owners. We like them to own a lot of stock. We like them to have reasonable options positions. And, we like them to have performance bonuses tied to measures that drive share value. But it is more than just economics. We also want managers that communicate with us like they would to their business partners. Timely, honest assessment of business performance, to us, is an entitlement of being a shareholder.
Read the complete speech
