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How to Determine a Good Investment

May 13, 2013 | About:
I just wrote this post on my investment process and the idea of using screens. I found it interesting that Buffett doesn't even consider screens as a tool. I think most of the reason is that he doesn't use technology much, but other reasons include the sheer size of his investment portfolio and the fact that since the 1980s he has become much more of a business investor interested in the qualitative aspects of a business. He is much more interested in moats, management and competitive advantages than he is about P/E or P/B ratios.

This is of course a huge departure from the investment methods he learned from Ben Graham, who didn't really care much about the underlying business, only what the value of the net tangible assets were currently in comparison to the stock price. Walter Schloss was the best practioner of Graham's methods, making 20% per year for 47 years.

My methods are a synthesis of those three investors, along with some things I've learned from Greenblatt. But Buffett of course is the best of them all, and I always learn something when he shares his ideas. I was reading through the Q&A from the recent Berkshire meeting, and this was a passage I thought was excellent:
"We’re looking at quantitative and qualitative. We’re not looking at aspects of a stock; we’re looking at aspects of a business. It’s important to have that mindset that we’re buying a business whether we’re buying shares or the entire company. When Charlie and I look at Value Line or reports or papers or whatever, for one thing we have cumulative of a good many industries and comps and not all by a long shot.

"Different numbers are of different importance depending on the kind of business. If you were a basketball coach you would if walking down the street and a 5’4” person said you ought to sign me up, you might have a prejudice against him but there might be one who’s good. And I might say good luck son, we’re looking for 7 footers, and then we have to worry about whether we can keep them coordinated and keep them in school. We see certain things that tell us, think further, look further. We’ve come up with the conclusion that we can’t make intelligent analysis of all kinds of businesses and usually some little fact slips into view that causes us to rethink something."
So Buffett is thinking about the business. He reads a lot, and he has built up a huge database of knowledge on a variety of industries, which is his circle of competence. He takes large concentrated positions, so he has to invest this way. He uses tactics that stray far from Graham, but the underlying philosophy is value. The next passage is in response to Doug Kass' rather silly question about Buffett maybe being too quick to make investment decisions, unlike his old days when he did tremendous due diligence:
"You mentioned how I had the Bank of America preferred stock idea in the bathtub, which was true, but the bathtub wasn’t the key factor. The truth is I read a book 50 years ago called “Bio of a Bank.” I’ve followed BAC and other banks for 50 years and even bought banks. So there are different things we think about in terms of a bank than we think about than when buying (something else)... certain things we think about when buying insurance. Different things depend on brands. Some brands travel very well – Coke is a great example — and some brands don’t travel. We just keep learning about things like that."
What a great response. in summary: "Yeah, I thought of BAC while I was in the bathtub, but it was an easy decision because I've studied banks for 50 years." I like how he says "we just keep learning." That's the key. Buffett, like Schloss (and like us here at BHI) love simplicity. Buffett can be simple because of his database he's built up over the course of his life. It's easy for him to determine value from a qualitative standpoint, just like it was easy for Schloss and Graham to determine quantitative value. Check out how simple his BAC thesis is:
"BAC in 2011 was subject to rumors, there was big short interest, morale was terrible. It struck me that an investment by Berkshire might be helpful to the bank and might be to us. I never met Brian, but gave him a call. Not because I calculated some precise P/E ratio, but because I have some idea of what the company may look like in five years and a reasonable amount of confidence and there was a disparity between price and value."
What? No spreadsheets? No 100 page thesis? no DCF or other projected earnings model? Nope, just a simple thesis and an easy conclusion that "there was a disparity between price and value." (By the way, the link is to Bruce Berkowitz's case study, which is a great learning tool, but you don't need a 100-page case study to justify making an investment.)

Determining if a disparity exists between price and value: That's all we are trying to do, and I think if we approach each investment decision with that simple logic, our results would improve, as would our efficiency.

About the author:

John Huber
I am the Portfolio Manager at Saber Capital Management, LLC. Saber manages an investment partnership as well as separately managed accounts for clients interested in a focused value investing strategy. My investment style has been most influenced by Ben Graham, Walter Schloss, Warren Buffett, and Joel Greenblatt. I am also the author of www.BaseHitInvesting.com, a value investing blog.

Visit John Huber's Website


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