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Start With the As?

April 12, 2014
Grahamites

Grahamites

150 followers

Adam Smith: If a younger Warren Buffett (Trades, Portfolio) were coming into the investment field today, what areas would you tell him to point himself in?

Warren Buffett (Trades, Portfolio): Well, if he were doing – if he were coming in and working with small sums of capital I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities and that bank of knowledge will do him or her terrific good over time.

Smith: But there’s 27,000 public companies.

Buffett: Well, start with the A’s.

I believe most of the readers are familiar with the “start with the A’s” advice from Warren Buffett (Trades, Portfolio). However, can you really start with the A’s with 27,000 companies?

I doubt it. Let’s do the big picture math. Assuming on average, one needs 10 hours to get familiar with a company. Then studying 27,000 companies requires 270,000 hours, the equivalent of 11,250 days and almost 31 years even if one utilizes all 24 hours a day solely on research. If an investor can only spend 3 hours a day on research, it will take him or her approximately 250 years to study every public company available in the U.S. Let’s not forget that the number of publicly traded company has gone up since then.

Granted, Buffett used a very quantitative approach in his early years so it may only take him not even 5 minutes to go through a company on Moody's manual. And to be fair, I think this approach may still work and will enable one to study considerably more companies than a qualitative based approach.

But the investing world has changed. The number of companies that fit Graham's quantitative screen has shrunk significantly. Under today's market condition, it would be foolish to mindless follow Mr. Buffett’s advice.

What if I told you we don’t have to study 27,000 companies to achieve superior returns. Heck, I would say 90%-95% of the companies are not even worth a minute. I think what makes most sense is simplifying the problem by making a list of the companies you want to study and then start with the A’s. This list may change over time, depending on the strategy that suits best with your temperament. I like businesses with a moat around it so my list includes high quality businesses that I can understand. You may prefer the net net approach so your list may include all publicly traded companies priced below net tangible book value.

Once we have created our own list, then we can comfortably start with the A’s.

Here is how I came up with my list. Morningstar has a wide moat list and I use this list as my starting point. Morningstar’s list includes the following companies that start with Alphabet A.

Accenture PLC

Adobe Systems Inc

Allergan, Inc.

Altria Group Inc.

Amazon.com Inc

Ambev SA

American Express Co

AmerisourceBergen Corp

Amgen Inc

Analog Devices Inc

Anheuser-Busch Inbev SA

Applied Materials, Inc.

ARM Holdings PLC

AstraZeneca PLC

Autodesk, Inc.

Automatic Data Processing

Based on my personal experiences, I then added the following 4 companies in addition to Morningstar’s list:

Apple Inc

Advanced Auto Parts

Abbott Laboratories

AbbVie Inc

The next step involves simplification and elimination. I would cross out the companies that are out of my circle of competence (such most pharmceutical and bio tech companies) , companies that are too complicated, companies that are subject to rapid change and companies subject to potential material adverse regulation. This is what happens after I apply the filters:

Accenture PLC - keep

Adobe Systems Inc - eliminate, subject to rapid change

Allergan, Inc - eliminate, out of circle of competence

Altria Group Inc - eliminate, subject to potential material adverse regulation

Amazon.com Inc - keep

Ambev SA - keep

American Express Co- keep

AmerisourceBergen Corp - eliminate, out of circle of competence

Amgen Inc - eliminate, out of circle of competence

Analog Devices Inc - eliminate, subject to rapid change

Anheuser-Busch Inbev SA - keep

Applied Materials, Inc - keep

ARM Holdings PLC - eliminate, subject to rapid change

AstraZeneca PLC - eliminate, out of circle of competence

Autodesk, Inc - eliminate, out of circle of competence, also subject to rapid change

Automatic Data Processing - keep

Apple Inc - keep, but keep a close eye on

Advanced Auto Parts - keep

Abbott Laboratories - eliminate, out of circle of competence

AbbVie Inc - eliminate, out of circle of competence

After this round of simplification and elimination, I’ve narrowed my list down to 9 companies that start with A. It still takes a good amount of time to study these companies extensively but it won't take years.

Again, every value investor should find the approach that suits best with his or her own personality so what works for me may not work for you. The idea is to build a list of companies that you feel comfortable with and know them really well. As Buffett said, “that bank of knowledge will do him or her terrific good over time.”

So my advice to you: come up with a list of a companies that fits your temperament and style, then start with the As.


Rating: 4.4/5 (17 votes)

Voters:

Comments

John Huber
John Huber premium member - 8 months ago

Nice post Grahamites. I have a friend that runs a fund that basically relies solely on a similar "start with the A's" approach... no screeners or other idea generators, just going through the Russell 3000 (that's the list he chooses).

One thing I would point out. When Buffett went through his list of 10,000 or so, he was using Moody's manuals and other sources, and he has said that although he did this A-Z list twice, he often spent just a few seconds on many of the stocks.

Another thing that is interesting to note: he was looking for quantitative bargains at that stage in the game. He was looking for ideas where the numbers "hit him over the head like a baseball bat". And that's how he found ideas like Western Insurance at 1 times earnings, or the bus company paying a $50 dividend on a $35 stock, etc... extreme bargains.

He did do significant research, but he wasn't looking for moats in the early 50's, just bargains.

But I think your suggestion is excellent for investors wanting to develop a database and build up some knowledge on the high quality companies.

Speaking of Morningstar, I like their screening tool because it allows you to look back 10 years... I have a good A-Z list consisting of non-financials that have produced positive free cash flow in each of the last 10 years. This list currently has around 600 stocks, but would be a good A-Z list as you can eliminate many that you don't understand.

Your wide moat idea is also a good list.

Nice post!

Grahamites
Grahamites premium member - 8 months ago

John, thanks for the nice words and thanks for your insightful comments. I did edit the article a little bit to incorporate the suggestions you pointed out. They are great and valid points.

I think your list sounds fabulous and very logical. I'd be interested to see how much overlap there is between yours and Morningstar's wide moat because there seems to be a logical connection.

Please leave your comment:


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