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How Warren Buffett picks stocks

“Excellent business results by corporations will translate over
the long term into correspondingly excellent market value and
dividend results for owners, minority as well as majority,” Warren Buffett once said.

How true this is even today although Mr Buffett said this as far back as 1978 in a letter to Berkshire Hathaway shareholders for FY1977.

When it comes to marketable equity securities, the Berkshire Hathaway chairman selects them in much the same way as he would evaluate a business for full acquisition.

Mr Buffett lists four criteria for selecting securities:
(1) the business of the company must be one that he can understand;
(2) it must have favorable long-term prospects;
(3) it must be operated by honest and competent people; and
(4) the securities must be available at a very attractive price.

Notice the emphasis on long term?

In the words of the Berkshire Hathaway chairman: “We ordinarily make no attempt to buy equities for anticipated
favorable stock price behavior in the short term. In fact, if
their business experience continues to satisfy us, we welcome
lower market prices of stocks we own as an opportunity to acquire
even more of a good thing at a better price.”

In a point that underscores value investment, he said: “Our experience has been that pro-rata portions of truly
outstanding businesses sometimes sell in the securities markets
at very large discounts from the prices they would command in
negotiated transactions involving entire companies.
Consequently, bargains in business ownership, which simply are
not available directly through corporate acquisition, can be
obtained indirectly through stock ownership. When prices are
appropriate, we are willing to take very large positions in
selected companies, not with any intention of taking control and
not foreseeing sell-out or merger, but with the expectation that
excellent business results by corporations will translate over
the long term into correspondingly excellent market value and
dividend results for owners, minority as well as majority.”

Warren Buffett’s Rip Van Winkle approach

ripvanwinle
Statue of Rip van Winkle in Irvington, New York, not far from “Sunnyside”, the home of Washington Irving. – Wikipedia

In his letter (dated February 28, 1992 for FY1991) to Berkshire Hathaway shareholders, Warren Buffett gave an insight into his Rip Van Winkle approach to investing. Referring to a list of Berkshire Hathaway’s common stock holdings – comprising Capital Cities/ABC Inc, The Coca-Cola Company, Federal Home Loan Mortgage Corp, GEICO Corp, The Gillette Company, Guinness PLC,  The Washington Post Company and Wells Fargo & Company – Warren Buffett said:  “As usual the list reflects our Rip Van Winkle approach to investing. Guinness is a new position. But we held the other seven stocks a year ago (making allowance for the conversion of our Gillette position from preferred to common) and in six of those we hold an unchanged number of shares. The exception is Federal Home Loan Mortgage (“Freddie Mac”), in which our shareholdings increased slightly. Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.

“(With tongue only partly in check, I suggest that recent events indicate that the much-maligned “idle rich” have received a bad rap: They have maintained or increased their wealth while many of the “energetic rich” – aggressive real estate operators, corporate acquirers, oil drillers, etc. – have seen their fortunes disappear.) Our Guinness holding represents Berkshire’s first significant investment in a company domiciled outside the United States. Guinness, however, earns its money in much the same fashion as Coca-Cola and Gillette, U.S.-based companies that garner most of their profits from international operations. Indeed, in the sense of where they earn their profits – continent-by-continent – Coca- Cola and Guinness display strong similarities. (But you’ll never get their drinks confused – and your Chairman remains unmovably in the Cherry Coke camp.) ”

Warren Buffett then went on to give an insight into his selection criteria, saying: “We continually search for large businesses with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements. This focus doesn’t guarantee results: We both have to buy at a sensible price and get business performance from our companies that validates our assessment. But this investment approach – searching for the superstars – offers us our only chance for real success. Charlie and I are simply not smart enough, considering the large sums we work with, to get great results by adroitly buying and selling portions of far-from-great businesses. Nor do we think many others can achieve long-term investment success by flitting from flower to flower. Indeed, we believe that according the name “investors” to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”

Notable quote

This statement from Warren Buffett is worth repeating here: “Nor do we think many others can achieve long-term investment success by flitting from flower to flower. Indeed, we believe that according the name “investors” to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”

Warren Buffett continued: “If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long- term economic characteristics of each business; second, assess the quality of the people in charge of running it; and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products? (I was tempted to say “the real thing.”) Our motto is: “If at first you do succeed, quit trying.” ”

Warren Buffett then went on to share this view: ” John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934 that says it all: “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. . . . One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.”

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

Warren Buffett goes for the long haul

Warren Buffett goes for the long haul when it comes to marketable equity securities. As far back as March 14, 1978, he said in his FY1977 letter to stockholders of Berkshire Hathaway: “When prices are appropriate, we are willing to take very large positions in selected companies, not with any intention of taking control and not foreseeing sell-out or merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority.”

How does Warren Buffett pick marketable equity securities? In that same letter, he said:

“We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.”

Warren Buffett went on to say: “We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.”

What is Warren Buffett’s rationale?

“Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership,” he said in his FY1977 letter.

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

How Warren Buffett picks marketable securities

wallstreetfreeWarren Buffett said in his letter to shareholders in the 1977 annual report that Berkshire Hathaway selected marketable equity securities in much the same
way it would evaluate a business for acquisition in its entirety.
Warren Buffett said then: “We want the business to be (1) one that we can understand, (2)
with favorable long-term prospects
, (3) operated by honest and
competent people
, and (4) available at a very attractive price.”
The fourth point, “available at a very attractive price”, was changed to “available at an attractive price” in his letter to shareholders in the 1992 annual report.
“We have seen cause to make only one change in this creed: Because of both
market conditions and our size, we now substitute an attractive
price’ for ‘a very attractive price’,” Warren Buffett said in the 1992 annual report.
The consistency of Berkshire Hathaway’s investment creed can be seen in Warren Buffett’s letter to shareholders in the 2007 annual report.
Warren Buffett said then: “Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.” “Charlie” refers to Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway.

Recommended reading:
Berkshire Hathaway Letters to Shareholders, 1965-2013