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by Robert G. Hagstrom Jr.
reviewed by Marco den Ouden
This review was published at About.com on 08/26/97
The article is also available at
Stocknowledge
If anyone merits the title "the world's most successful
investor", it certainly is Warren Buffett. $10,000 invested with him in 1956
would today be worth over $150 million! His personal net worth is over $20
billion. Unlike most of the super-rich, Buffett made his fortune by investing.
Hagstrom presents a fascinating account of the man and
his methods. A quiet, unassuming person, Buffett does his own taxes and drives
his own car. He is, says Hagstrom, "gracious, kind and honest. He is also
enormously intelligent, quick and intuitive. A man of great warmth and personal
charm."
Hagstrom traces Buffett’s roots and development. In
university he read Benjamin Graham’s classic work, The Intelligent Investor
. So impressed was he by Graham that he left Omaha on graduation for New York
to study with Graham and later to work for him. When Graham retired, Buffett
returned to Omaha where he formed a limited investment partnership. It was 1956
and Buffett was 25.
Over the next thirteen years, the partnership grew at a
compounded rate of 29.5% per year. In 1962 he started acquiring shares of a
business in decline - the textile giant Berkshire Hathaway. B-H eventually
became the centerpiece and holding company for Buffett’s fortune. Since gaining
control of the company in 1965, the company has had an annual compound growth in
value of 23.3%. In that time it never lost value, even gaining during the severe
recession of 1973-1975. It outperformed the S&P 500 in all but three years. Its
shares have never been split and currently trade at around $45,000 a share, the
most expensive shares in the world. (Last year the company issued Class B shares
at 1/30th of the value of the Class A shares so small investors could buy in as
well.)
But while this history is interesting of itself, more
interesting still is Buffett’s style and philosophy. The key influence on his
style, as mentioned above, was Benjamin Graham. Another key influence was Philip
Fisher, author of Common Stocks and Uncommon Profits.
I won’t go into detail here, but simply put, Graham
developed the idea of value investing. He originated the principles of financial
analysis. He distinguished between investment and speculation. He encouraged a
conservative approach that focused on investing in companies with a margin of
safety. This meant focusing on stocks that were selling for less than two-thirds
of net asset value and/or buying stocks with low price-to-earnings ratios.
While Buffett says he is 85% Graham in his approach to
investing, he acknowledges that he is also 15% Fisher. Fisher promoted the idea
of looking closely at the quality of management. He interviewed managers,
customers and competitors to get a good handle on a prospective investment.
Hagstrom carefully explains how Buffett synthesized the
two approaches with great success. Much of the book goes into explaining
Buffett’s style, through both analysis and by following the history of Berkshire
Hathaway and its acquisitions.
Buffett approaches buying shares in a company as if he
were actually buying the whole business. Hagstrom discerns a set of basic
principles that govern this approach. They can be divided into four categories:
business tenets, management tenets, financial tenets and market tenets.
After explaining these principles in detail, Hagstrom
then shows how the tenets were applied to Berkshire Hathaway’s acquisitions. In
a future article I’ll go over these tenets in greater detail. For now suffice to
say that they range from a business being simple and understandable, to rational
and candid management, to examining profit margins and buying at attractive
prices.
Perhaps the most complex of Buffett’s tenets are the
concepts of "owner earnings" and determining the value of a company. Owner
earnings involves taking capital expenditure needs into consideration in looking
at a company’s profitability. Determining the value of a business involves
estimating future cash flows.
Hagstrom’s analysis of Berkshire Hathaway’s acquisitions
and how Buffett’s tenets apply is illuminating. On the rare occasion when
Buffett strayed from these tenets, USAir, for example, he ran into trouble. The
investment was an error, admits Buffett. When asked by a student why he invested
in USAir, Buffett quipped "Actually I have an 800 number now which I call if I
ever get the urge to buy an airline stock. I say ‘My name is Warren and I’m an
air-aholic’ and they talk me down."
In the concluding chapter, Hagstrom quotes George Bernard
Shaw who said, "The reasonable man adapts himself to the world. The unreasonable
one persists in trying to adapt the world to himself. Therefore all progress
depends on the unreasonable man." Buffett, concludes Hagstrom, is the
"unreasonable man" because he represents tremendous progress in the world of
investing. "When Buffett invests," says Hagstrom, "he sees a business. Most
investors see only a stock price." Buffett cares not whether the market is high
or low, bearish or bullish. He looks at the fundamentals of a business and bases
his decisions accordingly. It is deceptively simple, and yet so right.
In today’s hectic market, when the Dow Jones is hitting
new peaks, when bearish analysts warn of an impending recession or even a
depression and an imminent collapse of all stock values, Buffett’s approach, as
summarized by Hagstrom, can only bring the investor following it great peace of
mind. And what is the Warren Buffett Way?
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Step 1: Turn off the stock market.
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Step 2: Don’t worry about the economy.
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Step 3: Buy a business, not a stock
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Step 4: Manage a portfolio of businesses.
Hagstrom presents us with a man of great personal charm
and warmth, and a man who is without question a genius at what he does. The book
is a superb read and highly recommended.
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