Q: Can you describe briefly how you started on your journey in the world of Value Investing?
Warren: Sure. I graduated at 19 from the University of Nebraska-Lincoln. In 1951, I earned a Master’s degree in Economics from Columbia University in New-York, where I’ve learned from Benjamin Graham. Graham gave me an A+ in his investing course, the first time he has given such a grade in his 22 years of teaching. I felt very lucky when Ben Graham called me in 1954, three years after my graduation, and offered me an analyst (a statistician, they called it back then) position in his Graham-Newman partnership. I worked there until Graham liquidated the partnership in 1955. Graham had an immense influence on me. He had taught me to treat stocks like part ownerships in businesses, not as trading tickers. He introduced me to the concept of margin of safety, and to the merits of being rational and being contrarian. Graham taught me that Price is what you pay, Value is what you get. At Graham-Newman, I was picking net-nets like everybody else. Even after breaking out on my own, early in my own partnership years, I was buying the same Graham-type Cigar-butt distressed securities. Nevertheless, I have changed my investing style over the years. Charlie [Munger] exposed me the merits of buying great businesses with enduring competitive advantages, even if paying up a little bit more, and holding those securities for very long periods of time. Charlie also exposed me to Phillip Fisher. In 1987, I said in an interview that “I am 85% Graham and 15% Fisher”. Today, I believe that I am much closer to Fisher and Munger than to Graham. Ever since I started investing, I worked rigorously to build a circle of competence that would allow me to understand better the companies I invest in. Early in my career, I built a circle of competence in Industrials, Transportation, Banks, and Financials and have expanded it over the years to other types of industries and situations. I have spent more time in analyzing businesses and industries than anyone I know. I buy stocks after a long and rigorous study, capitalizing on knowledge and experience gained through decades of study. I am a very long term investor, and my preferred holding time is forever.
Walter: I didn’t go to college. In 1934, when I was 18, my family didn’t have much money, so I went to work as a runner in the stock exchange. After a few years, I was promoted to being a cashier. I wanted to be an analyst (a statistician, they called it), but they wouldn’t let me, having no formal education and all. The boss at the statisticians department recommended that I read “Security Analysis” by Ben Graham. so I did, and eventually also attended a night course on investing that he had given to Wall Street employees. I was drafted and served in the army for a few years but kept writing to Graham every once in a while. In 1946 he offered me a statistician position, and there I was, searching for net-nets alongside Ben Graham. Warren joined in 1954. When Graham retired, I started my own partnership with only 19 partners. Throughout my 47 years of investing, I did pretty much the same thing. I maintained a portfolio of 60 – 100 stocks, often hated and distressed, but bought them very cheaply. At first, we bought working-capital stocks (a.k.a net-nets). When those weren’t around, we bought securities trading at ⅔ of book. When those disappeared, we bought securities around book value. We remained close to Graham’s approach. Like Warren, I stay out of speculations, and I adhere to the concept of margin of safety. I try not to get emotional. Graham taught us to look at the numbers and to insist on buying cheap. Buying good quality stocks can be profitable, but it’s not something that Graham did very often, and nor did I.
Q: What are the most important things for you in investing?
Warren: My first rule in investing is not to lose money. Everyone knows the second rule (don’t forget the first rule). I do not make new investments very often, and when I do, I insist on a margin of safety and buy stocks that are cheap in relation to their earning power. Naturally, I do not always succeed. For example, only recently, I lost money on Tesco.
I think it is very important to develop a circle of competence. Risk comes from not knowing what you’re doing. Therefore, my analysis is deep and thorough and relies on years of study.
The third most important thing in investing, I would say, is the insistence on high-quality companies, those that have rock-solid moats, and earn high returns on invested capital. It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Time is the friend of the wonderful company, the enemy of the mediocre.
Walter: Well, like Warren, I don’t like to lose money. I believe that price is the most important factor in investing. The quality of the issue is only secondary. The companies we buy are not very good ones, often they are not profitable. We buy stocks that other investors are too scared to hold, and we buy them at very low valuations. We are heavily diversified and hold 60 to 100 positions at a given time. Some of the companies we buy work out well and some of them don’t. We do lose money on some of the holdings, but we don’t lose money on the portfolio as a whole.
Warren insists on quality…high returns on capital…moats…Warren understands businesses – we don’t. Warren understands insurance businesses – we don’t. And he understands banking and publishing companies. We’re buying in a way that we don’t have to be too smart about the business….Like Warren says, we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
Q: What attributes you are looking to find in an investment?
Warren: We look for superior management teams running the companies we buy. The best thing I did was to choose the right heroes. It’s better to hang out with people better than you. Pick out associates whose behavior is better than yours and you’ll drift in that direction. Nevertheless, the quality of the business is important nonetheless and even matters more than the quality of the management. I have discovered that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. Therefore, we only buy stocks that we’d be perfectly happy to hold if the market shut down for 10 years. If a business does well, the stock eventually follows.
Walter: Warren wants franchises and good businesses. We do too, but we’re not willing to pay for them so we don’t buy them. I guess we buy difficult businesses. As Warren would say, he likes to row downstream and we like to row upstream.
When buying a stock, I find it helpful to buy near the low of the past few years. I also look for stocks selling below book value or near book value. I look into the history of the company. I focus on downside protection. Ben [Graham] taught me that If you take care of the downside, the upside will take care of itself.
As for the quality of management, yes, it is important to me, but unlike Warren, I avoid speaking with management. I don’t think I’m a good judge of character as Warren is. Warren could go to an annual meeting and because he’s very analytical and not emotional about it, he could analyze what goes on without being swayed by the fact that the guy talks well, acts well or whatever. He could probably do it. He’s very good at it. I don’t think I would be. We just try to buy cheap stocks. That’s really all. We try to buy things that are out of favor – stocks that others don’t want.
Q: What stocks do you avoid?
Warren: I do not like debt and do not like to invest in companies that have too much debt, particularly long-term debt. With long-term debt, increases in interest rates can drastically affect a company’s profits and make future cash flows less predictable. It’s not debt per se that overwhelms an individual corporation or country. Rather it is a continuous increase in debt in relation to income that causes trouble. Also, I am not fond of technology companies, simply because I don’t understand their long-term business dynamics. Technology companies change too rapidly. Our approach is very much profiting from a lack of change rather than from change. I’ll give an example – Wrigley chewing gum. With Wrigley chewing gum, it’s the lack of change that appealed to me. I don’t think it is going to be hurt by the Internet. That’s the kind of business I like.
Walter: I don’t like stock with more than a little bit of debt. You have to be careful about leverage. It can go against you. Other than that, if it is cheap, and it doesn’t have a lot of debt, I’ll buy it. Over the years, we have bought stocks of any industry, ranging from IBM to Disney and to Wells Fargo.
Q: How long are you willing to hold an investment?
Warren: My favorite holding period is forever. We only buy something that we’d be perfectly happy to hold if the market shut down for 10 years. We make money by buying shares in companies that earn a high return on invested capital, thanks to their enduring moats. We associate with great management teams and let them do what they do best. The irony is that while Graham was a quantitative investor, he made more money by investing in Geico (a growth stock), which he held for a very long period than all the other investments his firm ever made – combined.
Most of our large stock positions are going to be held for many years and the scorecard on our investment decisions will be provided by business results over that period, and not by prices on any given day. Just as it would be foolish to focus unduly on short-term prospects when acquiring an entire company, we think it equally unsound to become mesmerized by prospective near term earnings or recent trends in earnings when purchasing small pieces of a company.
Walter: Have patience. Stocks don’t go up immediately. Many stocks we buy take years to work out. They don’t go up right away after you buy them. A stock gradually works itself into a good position and you become familiar with it. If you sell it because its relative value isn’t there, you have to sweat out the new one for three more years. There’s a life cycle to these things. Our average holding period is between three and five years. If we owned the same 5 companies for the next 10 years because we believed in the businesses and all we did was to sit here and look at each other, it would be no fun. It may be a profitable way of investing, but you have to have some fun in what you do. Besides, once the mispricing is gone, we do not stick with the mediocre companies we buy. We move on to find other mispriced opportunities.
Q: What is your approach to selling a position?
Warren: When a stock does no longer meet my investment criteria, I sell. No excuses. I invest based on understanding the long-term dynamics of the business and the industry, making a judgment that the company can earn above-average returns on invested capital. When something changes and the thesis is no longer intact, I sell. Nevertheless, over the years I have refrained from selling even when I should have. In my 2004 letter to shareholders, I wrote, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked.
Walter: I guess we’re selling at a price we think is reasonable, fairly valued. And we’re probably selling it too soon – because lots of fair value stocks go up a lot more. Some people have asked me if we switch, i.e. sell a stock to buy another cheaper stock. Well, I don’t think we switch. Theoretically, that would be the smartest thing to do – when you find something cheaper, sell A to buy B. Logically, we should – we should say if this company is cheaper…But it’s very difficult to judge the relative values of companies in different fields. It’s difficult to come up with a figure. Also, many stocks we buy take years to work out. They don’t go up right away after you buy them. A stock gradually works itself into a good position and you become familiar with it. If you sell it because its relative value isn’t there, you have to sweat out the new one for three more years. There’s a life cycle to these. So we don’t like to switch out of A into B. If we want to sell A, we’ll sell A. If we want to buy B, we’ll buy B. But we won’t sell A to buy B.
Q: What was your biggest investing mistake?
Warren: One of my biggest mistakes, which I have written about in my 1989 letter to shareholders, was in buying control of Berkshire. Though I knew its business – textile manufacturing – to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal. If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long- term performance of the business may be terrible. With Berkshire, I was allured to low price to book value multiple, yet I held it for the long term, rather than take the last puff out of this cigar butt and move on. I eventually turned it into my investing vehicle and you all know how the story came about.
Walter: Well, I don’t remember a striking mistake that we’ve made. I can point out small mistakes like buying companies with management whose reputation wasn’t great. We learned the lesson of buying companies which are run by management with a good reputation. The other type of mistake was being too conservative, at times. We were buying first mortgage bonds, back in the day. They turned out well, but the junior bonds worked out even better.
You see, we are heavily diversified, having positions in 60 to 100 stocks. When we make an occasional mistake, the impact is usually not very significant. We do not regard stocks that depreciate, or even wiped out, as mistakes. We invest in distressed companies – we know that some will work well, and the others will not. Our portfolio as an aggregate will do well, not this or that stock. We believe Warren did wisely buying Berkshire back in the ’60s. It was cheap because nobody wanted to own a dying textile business. Warren’s mistake was sizing his position too large. His other mistake was falling in love with the stock, rather than taking a 50%-100% profit and move on.
Q: What is your approach to diversification?
Warren: Wide diversification is only required when investors do not understand what they are doing. You won’t find great companies with enduring business advantages, being run by superior management too often. When you do find such a compounding machine, make a large bet. An investor should act as though he had a lifetime decision card with just twenty punches on it. Buy the best companies after you’ve done thorough research. With this method, you won’t be able to invest in more than a handful of great companies.
Walter: One of the things we’ve done – Edwin and I – is held over a hundred companies in our portfolio. Now Warren has said to me that, that is a defense against stupidity. And my argument was, and I made it to Warren, we can’t project the earnings of these companies, they’re secondary companies, but somewhere along the line some of them will work. Now I can’t tell you which ones, so I buy a hundred of them.
Q: What skills should an investor possess?
Warren: I’ll start by quoting my friend and partner Charlie Munger. Charlie said, have a lot of assiduity. I like that word because it means: sit down on your ass until you do it. Be rigorous, work hard, and develop your circle of competence. There are little tiny areas, as I said, in an Adam Smith interview a few years ago, where if you start with A and you go through and look at everything — and look for small securities in your area of competence where you can understand the business and occasionally find little arbitrage situations or little wrinkles here and there in the market — I think working with a very small sum, there is an opportunity to earn very high returns.
Walter: An investor should try to be rational, rather than being emotional. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for weaknesses in your thinking. Be honest, be fair. Try not to get too emotional.
Q: Can You Share Some Tips On Keeping Away From Being Emotional?
Warren: The key to overcoming emotions is being able to retain your belief in the real fundamentals of the business, and don’t get too concerned about the stock market. Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing. And that temperament is not being emotional. Be fearful when others are greedy, and greedy when others are fearful.
Walter: I try to have a very organized lifestyle and avoid and noise and hassle of Wall Street. I work 9 to 4, with a very well-defined method which I have learned more than 50 years ago from Graham. I avoid news and analyst coverage. I also don’t speak with management. I think I agree with Ben Graham. He didn’t like to speak with management because he thought he would be influenced by what they said. On the other hand, if you’re smart enough…. Warren could go to an annual meeting and because he’s very analytical and not emotional about it, he could analyze what goes on without being swayed by the fact that the guy talks well, acts well or whatever. He could probably do it. He’s very good at it. I don’t think I would be.