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Stepan Lavrouk
Stepan Lavrouk
Articles (422) 

Tom Russo: 2 Lessons I Learned From Warren Buffett

There are different ways of looking at the margin of safety

June 22, 2019

Tom Russo (Trades, Portfolio) is a Managing Member of Gardner Russo & Gardner and a General Partner of Sempre Vic Partners. As an investor, he looks for long-term value businesses, particularly family-owned businesses. All today, he manages over $12 billion in assets. He recently gave an interview in which he talked about two key investing lessons that he learned from Warren Buffett (Trades, Portfolio).

Two ways of looking at the margin of safety

Russo explains the difference between Buffett’s early-life strategy of buying ‘cigar butt’ companies, and his later approach of buying great businesses at fair prices:

“Warren at our class [at Stanford Business School] said that the only break the government gives is the non-taxation of unrealised gains. So invest accordingly. That’s different than the ‘50 cent dollar bill’ approach that he had used as a starting investor when he bought liquidating trusts and other instruments.

The discounted price was the margin of safety [for ‘50 cent dollars’]. The trouble is, to get a return from that - the asset is not growing in value - you have to close the discount. Take the cash, pay taxes, move on, try to find another one. But the fact is, another way to look at a margin of safety is as a business’s capacity to reinvest, and the strength of its competitive advantage. Then you don’t have to sell”.

In the ‘cigar butt’ approach, the margin of safety is the price you pay - even if your valuation is off by some amount, you know that you are approximately right. In the ‘great businesses’ approach, the margin of safety is the quality of the company - even if you overpay, you know that the difference will eventually be made up. Both are a form of insurance against mispricing and fundamentally represent the same thing.

Agency costs

“The second lesson was that you can’t make a good deal with a bad person. That’s [the concept of] agency cost. That’s when you give your money to a third party to invest on your behalf and they want to make it on their behalf. And that is something that is rife in the investment world and you have to guard against that”.

The idea is that if you’re holding a company for a long time, you are trusting management to reinvest capital in that business. As an investor you have to be sure that the executive and board is deploying that money in your interest, rather than their own. You would want them to pursue a course of action that ensured long-term stability, rather than a short-term increase in the stock price, so, for instance, choosing to devote more money to capex than share repurchases.

The problem is that management can often opt for the short-term gain, particularly if their incentives are distorted by free stock options. For this reason, successful long-term investing must necessarily involve a judgement of character, as well as a good assessment of financial strength.

Disclosure: The author owns no stocks mentioned.

About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

Rating: 5.0/5 (3 votes)

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Comments

claytongsimpson
Claytongsimpson - 1 month ago    Report SPAM
I would not lear stuff from Warren Buffett (Trades, Portfolio)

Mia Begum
Mia Begum - 1 month ago    Report SPAM

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claytongsimpson
Claytongsimpson - 1 month ago    Report SPAM

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