What does warren buffett invest in?

Buffett follows the Benjamin Graham school of value investing, which looks for securities whose prices are unjustifiably low based on their intrinsic worth. Rather than focus on supply and demand intricacies of the stock market, Buffett looks at companies as a whole.

Warren Buffett: The Making of an American Capitalist, Roger Lowenstein (New York: Random House, 1995).

Roger Lowenstein begins his new biography of Warren Buffett with a disclaimer. He reveals that he is a longtime investor in Berkshire Hathaway, the company that under Buffett’s guidance has seen its share price rise in 33 years from $7.60 to approximately $30,000.

In reviewing Lowenstein’s book, I must begin with a disclaimer, too. I can’t be neutral or dispassionate about Warren Buffett, because we’re close friends. We recently vacationed together in China with our wives. I think his jokes are all funny. I think his dietary practices—lots of burgers and Cokes—are excellent. In short, I’m a fan.

It’s easy to be a fan of Warren’s, and doubtless many readers of Buffett: The Making of an American Capitalist will join the growing ranks. Lowenstein’s book is a straightforward account of Buffett’s remarkable life. It doesn’t fully convey what a fun, humble, charming guy Warren is, but his uniqueness comes across. No one is likely to come away from it saying, “Oh, I’m like that guy.”

The broad outlines of Warren’s career are well known, and the book offers enjoyable detail. Lowenstein traces Warren’s life from his birth in Omaha, Nebraska in 1930 to his first stock purchase at age 11, and from his study of the securities profession under Columbia University’s legendary Benjamin Graham to his founding of the Buffett Partnership at age 25. The author describes Buffett’s secretiveness about the stocks he picked for the partnership, and his contrasting openness about his guiding principle, which is to buy stocks at bargain-basement prices and hold them patiently. As Warren once explained in a letter to his partners, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.”

Lowenstein describes how Warren took control of Berkshire Hathaway and cash-cowed its dying textile business in order to purchase stock in other companies. The book traces how Berkshire evolved into a holding company and how its investment philosophy evolved as Warren learned to look beyond financial data and recognize the economic potential of unique franchises like dominant newspapers. Today Berkshire owns companies such as See’s Candy Shops, the Buffalo News, and World Book International, as well as major positions in companies such as American Express, Capital Cities/ABC (now Disney), Coca-Cola, Gannett, Gillette, and the Washington Post Company. It also is a major insurer that includes GEICO Corporation in its holdings.

Readers are likely to come away from the book’s description of Buffett’s life and investment objectives feeling better educated about investing and business, but whether those lessons will translate into great investment results is less than certain. Warren’s gift is being able to think ahead of the crowd, and it requires more than taking Warren’s aphorisms to heart to accomplish that—although Warren is full of aphorisms well worth taking to heart.

For example, Warren likes to say that there are no called strikes in investing. Strikes occur only when you swing and miss. When you’re at bat, you shouldn’t concern yourself with every pitch, nor should you regret good pitches that you don’t swing at. In other words, you don’t have to have an opinion about every stock or other investment opportunity, nor should you feel bad if a stock you didn’t pick goes up dramatically. Warren says that in your lifetime you should swing at only a couple dozen pitches, and he advises doing careful homework so that the few swings you do take are hits.

Warren follows his own advice: When he invests in a company, he likes to read all of its annual reports going back as far as he can. He looks at how the company has progressed and what its strategy is. He investigates thoroughly and acts deliberately—and infrequently. Once he has purchased a company or shares in a company, he is loath to sell.

His penchant for long-term investments is reflected in another of his aphorisms: “You should invest in a business that even a fool can run, because someday a fool will.”

He doesn’t believe in businesses that rely for their success on every employee being excellent. Nor does he believe that great people help all that much when the fundamentals of a business are bad. He says that when good management is brought into a fundamentally bad business, it’s the reputation of the business that remains intact.

Warren likes to say that a good business is like a castle and you’ve got to think every day, Is the management growing the size of the moat? Or is the moat shrinking? Great businesses are not all that common, and finding them is hard. Unusual factors combine to create the moats that shelter certain companies from some of the rigors of competition. Warren is superb at recognizing these franchises.

Warren installs strong managers in the companies Berkshire owns and tends to leave them pretty much alone. His basic proposition to managers is that to the degree that a company spins off cash, which good businesses do, the managers can trust Warren to invest it wisely. He doesn’t encourage managers to diversify. Managers are expected to concentrate on the businesses they know well so that Warren is free to concentrate on what he does well: investing.

My own reaction upon meeting Warren took me by surprise. Whenever somebody says to me, “Meet so-and-so; he’s the smartest guy ever” or “You’ve got to meet my friend so-and-so; he’s the best at such and such,” my defenses go up. Most people are quick to conclude that someone or something they encounter personally is exceptional. This is just human nature. Everybody wants to know someone or something superlative. As a result, people overestimate the merit of that to which they’ve been exposed. So the fact that people called Warren Buffett unique didn’t impress me much.

In fact, I was extremely skeptical when my mother suggested I take a day away from work to meet him on July 5, 1991. What were he and I supposed to talk about, P/E ratios? I mean, spend all day with a guy who just picks stocks? Especially when there’s lots of work to do? Are you kidding?

I said to my mom, “I’m working on July fifth. We’re really busy. I am sorry.”

She said, “Kay Graham will be there.”

Now, that caught my attention. I had never met Graham, but I was impressed with how well she had run the Washington Post Company and by her newspaper’s role in political history. As it happened, Kay and Warren had been great friends for years, and one of Warren’s shrewdest investments was in Post stock. Kay, Warren, and a couple of prominent journalists happened to be in the Seattle area together, and owing to an unusual circumstance they all squeezed into a little car that morning for a long drive to my family’s weekend home, which is a couple of hours outside the city. Some of the people in the car were as skeptical as I was. “We’re going to spend the whole day at these people’s house?” someone in the cramped car asked. “What are we going to do all day?”

My mom was really hard core that I come. “I’ll stay a couple of hours, and then I’m going back,” I told her.

When I arrived, Warren and I began talking about how the newspaper business was being changed by the arrival of retailers who did less advertising. Then he started asking me about IBM: “If you were building IBM from scratch, how would it look different? What are the growth businesses for IBM? What has changed for them?”

He asked good questions and told educational stories. There’s nothing I like so much as learning, and I had never met anyone who thought about business in such a clear way. On that first day, he introduced me to an intriguing analytic exercise that he does. He’ll choose a year—say, 1970—and examine the ten highest market-capitalization companies from around then. Then he’ll go forward to 1990 and look at how those companies fared. His enthusiasm for the exercise was contagious. I stayed the whole day, and before he drove off with his friends, I even agreed to fly out to Nebraska to watch a football game with him.

When you are with Warren, you can tell how much he loves his work. It comes across in many ways. When he explains stuff, it’s never “Hey, I’m smart about this and I’m going to impress you.” It’s more like “This is so interesting and it’s actually very simple. I’ll just explain it to you and you’ll realize how dumb it was that it took me a long time to figure it out.” And when he shares it with you, using his keen sense of humor to help make the point, it does seem simple.

Warren and I have the most fun when we’re taking the same data that everybody else has and coming up with new ways of looking at them that are both novel and, in a sense, obvious. Each of us tries to do this all the time for our respective companies, but it’s particularly enjoyable and stimulating to discuss these insights with each other.

We are quite candid and not at all adversarial. Our business interests don’t overlap much, although his printed World Book Encyclopedia competes with my electronic Microsoft Encarta. Warren stays away from technology companies because he likes investments in which he can predict winners a decade in advance—an almost impossible feat when it comes to technology. Unfortunately for Warren, the world of technology knows no boundaries. Over time, most business assets will be affected by technology’s broad reach—although Gillette, Coca-Cola, and See’s should be safe.

One area in which we do joust now and then is mathematics. Once Warren presented me with four unusual dice, each with a unique combination of numbers (from 0 to 12) on its sides. He proposed that we each choose one of the dice, discard the third and fourth, and wager on who would roll the highest number most often. He graciously offered to let me choose my die first.

“Okay,” Warren said, “because you get to pick first, what kind of odds will you give me?”

I knew something was up. “Let me look at those dice,” I said.

After studying the numbers on their faces for a moment, I said, “This is a losing proposition. You choose first.”

Once he chose a die, it took me a couple of minutes to figure out which of the three remaining dice to choose in response. Because of the careful selection of the numbers on each die, they were nontransitive. Each of the four dice could be beaten by one of the others: die A would tend to beat die B, die B would tend to beat die C, die C would tend to beat die D, and die D would tend to beat die A. This meant that there was no winning first choice of a die, only a winning second choice. It was counterintuitive, like a lot of things in the business world.

Warren is great with numbers, and I love math, too. But being good with numbers doesn’t necessarily correlate with being a good investor. Warren doesn’t outperform other investors because he computes odds better. That’s not it at all. Warren never makes an investment where the difference between doing it and not doing it relies on the second digit of computation. He doesn’t invest—take a swing of the bat—unless the opportunity appears unbelievably good.

One habit of Warren’s that I admire is that he keeps his schedule free of meetings. He’s good at saying no to things. He knows what he likes to do—and what he does, he does unbelievably well. He likes to sit in his office and read and think. There are a few things he’ll do beyond that, but not many. One point that Lowenstein makes that is absolutely true is that Warren is a creature of habit. He grew up in Omaha, and he wants to stay in Omaha. He has gotten to know a certain set of people, and he’d like to spend time with those people. He’s not a person who seeks out exotic new things. Warren, who just turned 65, still lives in the Omaha house he bought for himself at age 27.

His affinity for routine extends to his investment practices, too. Warren sticks to companies that he is comfortable with. He doesn’t do much investing outside the United States. There are a few companies that he has decided are great long-term investments. And despite the self-evident mathematics that there must be a price that fully anticipates all the good work that those companies will do in the future, he just won’t sell their stock no matter what the price is. I think his reluctance to sell is more philosophical than optimization driven, but who am I to second-guess the world’s most successful investor? Warren’s reluctance to sell fits in with his other tendencies.

Warren and I share certain values. He and I both feel lucky that we were born into an era in which our skills have turned out to be so remunerative. Had we been born at a different time, our skills might not have had much value. Since we don’t plan on spending much of what we have accumulated, we can make sure our wealth benefits society. In a sense, we’re both working for charity. In any case, our heirs will get only a small portion of what we accumulate, because we both believe that passing on huge wealth to children isn’t in their or society’s interest. Warren likes to say that he wants to give his children enough money for them to do anything but not enough for them to do nothing. I thought about this before I met Warren, and hearing him articulate it crystallized my feelings.

Lowenstein is a good collector of facts, and Buffett is competently written. Warren has told me that the book is in most respects accurate. He says he is going to write his own book someday, but given how much he loves to work and how hard it is to write a book (based on my personal experience), I think it will be a number of years before he does it. When it comes out, I am sure it will be one of the most valuable business books ever.

Warren Buffett is probably the most known proponent of value investing: his investment philosophy is deceptively simple. Berkshire Hathaway’s objective is to buy ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics.” Obviously, the economics of the transaction itself need to be favorable.

Buffett himself has depicted this philosophy of spotting undervalued companies with the image of a cigar butt - a mostly used cigar ignored by others but still has a few risk-free puffs left.

He divides his portfolio into five macro-groups, ranked below in the order of contribution to his bottom line in 2018:

He looks at what he thinks is the probability of losing capital on a transaction (through a deterioration in the total value of the business or the financial instrument), in backing strong and diligent managers, and in evaluating the intrinsic value of a transaction. He defines this as the discounted value of the cash that can be taken out of the business in its remaining life. The cash figure that he uses for this calculation is what he defines as “owner earnings.”

He also believes in looking at long-term economic value, net of all costs, not just those that are considered accounting expenses. He is wary of mark-to-market practices, as he believes that volatility in the bottom line is a distraction.

In order to perform a calculation for intrinsic value, however, one needs to invest only in businesses that are not too complex to understand.

Owner’s Earnings Formula

Over the life of the company, the relationship between intrinsic and market value will look somewhat like this:

Share Intrinsic Value

From a purely financial angle, he is an ardent advocate of limiting leverage, retaining earnings, and of repurchasing shares if those shares are underpriced. We describe some main points of Warren Buffett’s investment strategy below:

He has long used his interests in property and casualty insurance companies as a way to fund the purchases of other businesses: This is because of the business model of insurance companies, which we graphically illustrate below:

Berkshire Hathaway Investment Model

Warren Buffett is renowned for being humble: He credits much of his investment successes to what he calls “The American Tailwind,” meaning the sustained prosperity that the US has enjoyed since the end of World War II. He points out that simply investing in the stock market at the time he made his first investment would have generated a return of 5,288 for 1 (net of any fees and taxes).

This economic buoyancy is set to continue in his opinion, and he has thus not invested recently in currencies or much outside of the United States.

He does, however, think that, at the moment, valuations for private companies are too high, particularly for those with good economic prospects and a long life. This is a view that I wholeheartedly share, particularly for high-growth tech companies—here is the link to the 2019 KKR macro outlook which I found to be very interesting reading. This view is reflected by Berkshire Hathaway’s latest asset allocation amongst the five pillars we described above: He has prioritized marketable securities and kept additional resources in cash and cash equivalents, hoping to come across an appropriately valued company to purchase.

An additional risk that Warren Buffett has flagged is that of a catastrophic insurance event; ones that he has mentioned are environmental disasters and cyber attacks.

Even Warren Buffett has made several errors during his long career, and he is very open in discussing them. We will cover some of them here to derive some interesting lessons.

Waumbec Mills consisted of a group of textile mills located in New Hampshire that Berkshire Hathaway acquired in 1975 for less than the value of the working capital. Effectively, they took everything over for free, outside of the excess receivables and inventory—understandably, a deal that would be hard to turn down. How did he then go wrong? He was seduced by the low price at which he could secure the transaction and misinterpreted the long-term economic viability of the milling industry. A key lesson that he has derived from this incident and others is that focusing on bargain hunting is not necessarily conducive to long-term value. He now prefers to own smaller stakes in better companies than entire struggling businesses.

Clearly, the textile industry has not been that auspicious for Mr. Buffett. It is also strange to think now of Berkshire Hathaway as a business on which he lost a lot of money. This is perhaps a cautionary tale on revenge and acting out of spite. He was already a shareholder in the business in 1962 when he received a verbal offer to purchase his shares from the man that was running Berkshire Hathaway at the time, Seabury Stanton. When he received the official offer at a lower price than had been agreed, he decided to no longer sell, but instead buy all the BH stock he could get his hands on and fire Stanton. He was ultimately successful in his revenge but was also now the proud owner of a failing textile business.

Dexter Shoes was a shoe business based in Maine that made good-quality, durable shoes. Warren Buffett believed that this quality and durability provided them with a competitive advantage when he acquired Dexter Shoes in 1993. Unfortunately, by 2001 Dexter Shoes had to close their plants because of the increased competition of cheaper shoes produced outside of the US. Not only was the investment thesis wrong, but losses from the transaction were made even worse by the fact that the acquisition was fully made in Berkshire Hathaway stock. This meant it hurt shareholder value, as he gave away some of their shares for something that ultimately was worthless. He has since become a big proponent of holding even larger cash buffers for acquisitions and of using cash only.

In 1987, Warren Buffett acquired a $700 million stake in Salomon Brothers, a prestigious bond trading house and investment bank. This was shortly before large write-downs caused by the stock market crash on Black Friday. This wiped a third off the value of BH’s investment. Over the next few years, the financial results of the investment bank remained extremely volatile and a number of scandals emerged, culminating in 1991 when it appeared that the trading desk had been submitting fake bids for government bonds, violating primary dealer rules set by the US Treasury, all with the knowledge of management. Warren Buffett was forced at this point to step in and take over the running of the firm, letting many people go and enforcing a culture of compliance. This was, in his words, a very “not fun” time, and a distraction from his duties of running the company. There were many problems at Salomon that persisted until it was sold in 1998: an aggressive and lax managerial and trading culture, excessive leverage (at one point, it had become $37 of assets vs. $1 of capital, higher even than Lehman when it collapsed).

Tesco is a large British supermarket chain in which Berkshire Hathaway had invested in 2006. He became one of the largest shareholders in the grocer, despite them issuing several profit warnings. In 2013, BH started selling some of their participation, albeit at a slow pace. When in 2014 the company was hit by a large accounting scandal for having overstated their earnings, BH was still the third largest shareholder. The lesson Warren Buffett drew from this expensive mistake was to be more decisive in getting out of this investment when he had lost faith in management and their practices.

It is very hard to say if the success of Warren Buffett and Berkshire Hathaway can ever be replicated even by very talented and shrewd investors. It was, as Mr. Buffett himself admits, the product, at least in part, of a prolonged and unprecedented period of economic growth and prosperity. Not only that fact, but the dynamics in global macroeconomics are changing; some of the largest and more valuable companies in the world are now in China or other emerging economies, and this may make it more difficult for global investors to both have access to them as investments and to be able to influence management as effectively as Mr. Buffett has been able to do in his home country, the US. Finally, Mr Buffett famously tends to stay away from technology investments and prefers more traditional business models. In the future, however, it is more likely that that will be the sector that is most likely to deliver great returns as we witness what Jeremy Rifkin has called the Third Industrial Revolution.