I recently had the pleasure of taking a large group of students to Omaha for a Q&A with Buffett. When available, I'll post the results of that Q&A if there is any interest here. In the meantime, I thought I'd mention my most memorable take-away from that meeting.A student noted that Buffett has been a much more successful investor than Graham, and yet Buffett attributes much of his success to Graham, why is that?For the first time, I heard Buffett address this issue head on. Buffett said that it's true, Graham never got really rich from investing. Ben was much more interested in ideas than in making money. However, the lessons Ben taught are very profitable (in order):1. Stocks represent part ownership in the business. Before Ben, Warren charted prices and did lots of other silly stuff. Ben's perspective was eye-opening.2. The concept of Mr. Market is vital. The market is very efficient, but not perfectly efficient--and that difference can make you very, very rich. At any point in time, the market price is usually, but not always, appropriate. An intelligent investor is one who can tell the difference between the current market price for a stock and a resonable interpretation of what that part of the business is really worth.3. The margin of safety concept is also vital. Once an intelligent investor discerns the difference between the current market price for a stock and a resonable interpretation of what that part of the business is really worth, it becomes important to build in an appropriate margin of safety.These lessons are Graham's most important contribution to Buffett and to you and me. Graham's sensible perspective, combined with Phil Fisher's (and T. Rowe Price's) insights on wonderful companies, has made all the difference for Buffett. If we are paying attention, they can make all the difference for us too.Mark
Professor Hirschey:Thank you for following in Graham's footsteps, and like the Legend, so generously sharing ideas and wisdom with us here at TMF.Your quick take-aways from the KU meetings are a real highlight of this board, and your full Q&A notes are always a pleasure to read.Thanks again!Shai
When available, I'll post the results of that Q&A if there is any interest here.of course there is interest!man, you really are redeeming yourself from those darker times (hint: LVLT) :-)I wish i could take students to WEB. Heck, I wish i HAD students!
You know I've probably read about Graham's influence on Buffett a thousand times but never once do I recall that it was so succinctly laid out in its core essential elements like this. Those three points are everything. Really enjoyed that - Thanks. If you don't mind, as an addition I'd like to add to the three core Graham elements some essential aspects of Fisher and Munger:1. Stocks represent part ownership in the business. 2. The concept of Mr. Market is vital. The market is very efficient, but not perfectly efficient--and that difference can make you very, very rich. At any point in time, the market price is usually, but not always, appropriate. 3. The margin of safety concept is also vital. Once an intelligent investor discerns the difference between the current market price for a stock and a resonable interpretation of what that part of the business is really worth, it becomes important to build in an appropriate margin of safety.4. When a purchase is made in part ownership of a business, seek to find only those businesses with wide, sustainable, enduring moats.5. Apply a multi-disciplinary analytical process to determine all of the above using the main ideas from the major disciplines to attack the problem from multiple ways. Then invert it.6. What reasonably considered psychological factors are having impact on my decision? Is it rational?7. Once you find the big gold nugget lying in plain sight on the ground, move decisively and make a big bet. Big ideas are rare.HB
attack the problem from multiple ways. Then invert it.hb, or others:I've seen this notion attributed to Munger, but I don't really understand it. Could you give a link or an example?I myself, particularly for a short position, try to think what I would be hoping for if I were long, how I would explain away the weaknesses of the position as being temporary, etc. The same obviously applies to chess, where one should think how one's opponent might exploit the position. Is this roughly what is meant?Thanks, gg
The best way to think about Munger's recommendation of inversion is to imagine that you are beginning a project or plan.Instead of starting with some ideas and then making the best of the outcomes along the way, Munger would recommend that you begin your plan or project by thinking first about your desired outcome.Then, you simply trace backwards the steps that need to occur in order for your ideal conclusion to happen.It's a very simple, yet powerful tool.
“attack the problem from multiple ways. Then invert it. hb, or others: I've seen this notion attributed to Munger, but I don't really understand it. Could you give a link or an example?”Hi there gg….. on the run at the moment so I'm going to have to truncate this a bit. “Multiple ways” refers to multi-disciplinary “attack” on the problem where you apply the most powerful, fundamental ideas from each major discipline onto any problem – in this case investing. The key to Munger the investor is to know the philosophy – you'll never find a “how to” script from a book for example… So to pick a few you might take say decision trees and compounding or the law of large numbers from mathematics and inversion from algebra and equilibrium theory and critical mass from physics and reversion to the mean from stats and autocatalysis from chemistry and advantages of scale from economics and then about five to ten or so from Psychology…. You apply these major ideas to the investing problem. I'll try to show you what I mean by applying just one of the above and then inverting it. Take Wal Mart… what is it about it that might mean it has a sustainable (the key quest) competitive moat? Why is critical mass important? Is size in this case an advantage or disadvantage? Does the law of large numbers apply to a company with $300 billion in annual revenue? Now if I approached this fundamental question from the aspect of induction (the norm for 99% of investors) I would say that WMT is the biggest company out there and that its huge size means that it will bump up against mathematical law of large numbers and its growth will slow substantially. I would be inclined to take a pass and not invest…… but…First going forwards (induction) I see that its size and critical mass gives it a monopsony power over its suppliers – WMT can dictate terms because it's the biggest seller on the planet – that means favorable downward pressure on pricing – a HUGE competitive advantage….and those suppliers are going to make up the difference by passing costs on to others with less power (the hated competitors). That is a HUGE advantage to WMT. You do a quick look at WMT's margins and see they've done nothing but increase for the past ten years – things are in order – definition of a probable moat. Critical mass doing its beautiful thing with the competition. But how do you get over that issue of huge size and the critical mass becoming an impediment due to large numbers? Invert…..How big can WMT get and how big is it now? How big does it have to get for you to have a decent return? The global retail market is about $7 trillion of which WMT has about a $300 billion share of – 4%. Global growth next ten years and you're probably looking at a global retail market of $10-11 trillion… Is WMT going to stand still with $300 billion? Nope. History (another discipline to apply) tells you that it's going to STEAL share from it competitors – it's done nothing but that for its entire life. What's reasonable? A 10% share of the global market in ten years going from 4% to 10%? Bud has what an 11% global market share in beer.... WMT has a 4% share in retail....hmmmmmm. Gillette? Wow. Maybe that 10% is ambitious but it's not unreasonable…. That's a risk but a reasonable risk to take I think. The inversion is to start at the end – the market size and then try to figure out how much of that market WMT can capture and what the company will be worth with that share…..back up to its share today and then do the math to figure out the rate of growth…. In my example above it's 12.8% compound growth in sales for a ten year period or less than a 1% gain per year in global market share…. In this case I conclude that because the global retail market is so damn huge that the law of large numbers is not yet a major factor to the investment thesis…. Your margin of safety comes in not only due to historical low prices based on its average but also based on the fact that in 10 years you'll have 15-20% fewer shares outstanding in addition to accumulated dividends…. That's my definition of taking some major themes and doing them forward and backward and yes I've had to cut a lot of corners to keep it short…. Munger talks a lot about multi-disciplinary thinking in his speech provided at the link below….. Ciao http://www.vinvesting.com/docs/munger/art_stockpicking.htmlHB
HB,The crux of what you are saying is as complex as the language, but I'm glad only bandwidth is involved and not trees. Why is it mispriced - what in this are the analysts and large institutional investors failing to see???
"Why is it mispriced - what in this are the analysts and large institutional investors failing to see???"I don't mean to sound flippant but I don't spend one second of time pontificating the answers to those two questions... couldn't care less. The focus should be on the business....not the analytical opinion of Street analysts who use metrics and a short term prism which I quite frankly find wanting... It's up to ME to figure out whether or not the price is rational given the future prospects. Ever notice what they always tend to focus on?? I mean really.... it's a joke - Quarterly earningsDecember salesDay after Thanksgiving volumeDecember marginsA scene at the front door of a Detroit storeA fight at the electronic sections counter of a single storeTwo labor union whackos dressed as Clause and elves passing out fake toys An executive's seeming evasiveness on holliday margins...etc...All of this is noise....meanwhile the company is going to open over 600 stores next year...they just bought a major grocery in Japan....a major outlet in Brazil... those are significant if not earth shattering stories and what do we hear.... Ask Simon and Garfunkle..."the sound of Silence".... typical media...HB
I don't mean to sound flippant but I don't spend one second of time pontificating the answers to those two questions... couldn't care less. The focus should be on the business....not the analytical opinion of Street analysts who use metrics and a short term prism which I quite frankly find wanting... It's up to ME to figure out whether or not the price is rational given the future prospects. Ever notice what they always tend to focus on?? I mean really.... it's a joke -Dear HB,OK, fine, but if the above is true, how could the following (from your earlier post) also be true?2. ...The market is very efficient, but not perfectly efficient--...At any point in time, the market price is usually, but not always, appropriate. Either the process is "a joke", or "usually appropriate", but not both. Now if markets are in general very efficient, would it be an inappropriate leap in logic to suggest that more significant and more frequent mispricings are apt to occur in more thinly traded traded (by definition less efficient) markets, and that the golden nugget is more likely to be found at the end of the road less travelled rather than the one leading to mega cap land ? If you think that a process that is generally "very efficient" and "usually appropriate" in pricing high profile issues has erred significantly on the downside, don't you feel at all compelled to convince yourself that you understand why why the issue is being marked down (and where error in Mr. Market's logic lies)?BTW, thanks for the link to Charlie's interview which I enjoyed a great deal (the interview that is, not the link) .. the multiple references to WMT did not go unnoticed.
abio87 writes:If you think that a process that is generally "very efficient" and "usually appropriate" in pricing high profile issues has erred significantly on the downside, don't you feel at all compelled to convince yourself that you understand why why the issue is being marked down (and where error in Mr. Market's logic lies)?At the risk of speaking out of turn...HB does not need to know why the market is undervaluing a security. He only has to recognize when it has done so.WMT went from $42 at the end of September to $49 today. Did the intrinsic value really change by so much in that time? Do you honestly believe the "efficient market" priced in something that was true three months ago but is no longer true today?I agree, in theory, that mispricings should be more common in the pink sheets. But what happened to WMT in the fall gives me pause.I do not know what "Mr. Market" was thinking in September. Maybe the S&P 500 rebalancing caused all the index funds to dump their positions at once. Maybe the automated stat arb strategies at the multi-billion-dollar hedge funds created some correlations that don't really belong (retail down = Wal-Mart down). Who knows? What I do know is that $42/share is, and was, a dumb-ass price for Wal-Mart stock. - Pat
"Now if markets are in general very efficient, would it be an inappropriate leap in logic to suggest that more significant and more frequent mispricings are apt to occur in more thinly traded traded (by definition less efficient) markets, and that the golden nugget is more likely to be found at the end of the road less travelled rather than the one leading to mega cap land?"Perhaps. And I've discussed this issue at some length with others here. It all goes back to philosophy and temperament and being true to yourself etc. If I find that it fits my psyche to load up on a few securities and bet big on high probabilities then I just find that this style (which fits me to a T) is best done (by me) on the big caps. Others may do a heck of a lot better with smaller stocks and in fact Munger has called it a "beguiling" idea. But if you're going to have a high degree of certainty and moat dominance those factors tend to be found primarily in the big names I think. The names may be big in the US but still be "small" globablly (BUD, WMT etc.).... At the right set of circumstances I could see loading up on a smaller company that had tons of room to run if it had a dominant moat. That said, by the time it's got a moat and by the time one can see that moat it almost by definition has to be a bit bigger. Something like Progressive or Moodys that's still fairly "small" but has a wide moat. Are there micro-caps out there with dominant, sustainable moats? I'm sure there are a few - there has to be - but how first see those moats and second how do those moats compare to WMT and Coke (getting cheaper by the day I might add)?....What I've found with most analytical opinion is that the most common mistake is to say that a moat exists when there isn't one. They don't spend enough time figuring out the true existence of a moat. They'll get the numbers right and the present value right, but they'll miss the moat.There are personal factors at work here as well and it's not insignificant. I have about 15-20 stocks that I can reasonably follow in my personal circumstances with my available time. I don't mean just follow but get to know them intimately. That takes a lot of my spare time. If I decided to look into the smaller arena I think that number would by definition have to increase. If it increased then I probably wouldn't know them as well and couldn't follow them as closely. I would add complexity into my life and it's already complex enough. I would then violate the sacred KISS principle. I would probaly lose some certainty and couldn't really load up - comfortably. I've given all of this a lot of thought BTW and just concluded that size matters. And, over a 1-2 year period there is ALWAYS something which happens to whack one of the big ones down....always. History is full of examples. Even if you have a gazillion analysts following a well known stock it stands to reason that if 99% of them are analyzing it in a wrong headed way that some mis-pricing will occur. HB
"HB does not need to know why the market is undervaluing a security. He only has to recognize when it has done so."Exactly. Why is it that Coke is selling for a cheaper valuation in December 05 than it was in December 04??? The company has had another year of improving performance. The sharecount is smaller. The earnings have increased. The volume has risen 5%.. They're bringing new products into the "Coca Cola system." They're addressing problems in Germany and the Phillipines. There are more people in the world today (bigger market). They have a CEO who is hell bent on being shareholder friendly. It defies logic and rationality to me that the market is pricing the company more cheaply now than then. HB
BRKA was at $82, on Oct 2. I'm sure hurricane fears factored in to that price but also in October I think everybody, "Mr. Market", gets nervous about the "crashes" or adjustments that frequently take place in October. October is hold your breath month.
Why is it that Coke is selling for a cheaper valuation in December 05 than it was in December 04??? Thanks for the reminder, HB and Pat... KO $45 Jan08 calls are priced at an implied volatility of between 12-14% depending on your risk free rate assumption. Great buy today, I think, and an example of how modern finance theory affords us some wonderful opportunities to profit from the divergence between its mathematical models and a grasp of reality. IMHO of course :-)-Mike
Why is Coke stock cheaper in December 2005 than December 2004? Look at their stock buybacks. You can have good business results in a year but if you pay too much to buy back stock, you reduce the value per share of the remaining stock.Roger
<snip>2. ...The market is very efficient, but not perfectly efficient--...At any point in time, the market price is usually, but not always, appropriate. Either the process is "a joke", or "usually appropriate", but not both. <snip>The MARKET is usually appropriate, the "experts" on Wall Street (at least the ones being interviewed for the financial shows) are a joke.Where is the contradiction?Gary Olmsteadwho thinks several of you should re-read WB's item #1....
Why is Coke stock cheaper in December 2005 than December 2004? Look at their stock buybacks. You can have good business results in a year but if you pay too much to buy back stock, you reduce the value per share of the remaining stock.Roger Well, you lost me on that one. Can you explain to me how the per share value of the remaining stock decreases as a result of the company buying back shares on the open market? Your caveat "if you pay too much to buy back stock" implies that the pps of KO was too high in December 2004 (or whenever the buybacks occurred,) meaning, higher than the per share stockholder equity value. Is that the case? Secondly, it seems the company would have to buy back a huge amount of stock for that to account for the difference in the KO pps.Am I missing something of import in your response?Hundriver
First, in talking about share buybacks, that is a part of the financial management of a company. Whereas selling the products and making money is a part of the business management of a company. A company can have excellent business management and poor financial management, for instance paying too much for stock in buybacks.The common belief is that all buybacks are good for the remaining shareholders. But a little thought reveals that this is clearly not true. Lets use Coke as an example. If Coke were to buy back shares for $100 per share, that would clearly be adverse to the best interests of the remaining shareholders. But if Coke were to buy back shares for $12 per share, that would clearly be beneficial to the remaining shareholders. So it is the price paid during the buyback, and to a lesser extent the source of the funds, that determine whether the remaining shareholders are better off or worse off.Looking at the balance sheet before the buyback(s) and afterwards is a good way to determine whether the buyback(s) benefitted the remaining shareholders. Another way of evaluating the buyback is to roughly estimate what the balance sheet would look like afterward if the company bought back one quarter of their outstanding stock for about the same price as that of the buyback(s).Since we know that the business of Coke is a good one and well managed, then the stock market has been telling us on average over the last five years that Coke's stock buybacks have not been good for the remaining shareholders. The question that we are left with now is whether Coke's excellent business management can overcome Coke's poor financial management.
P.S. to my previous post is that Bed Bath and Beyond (BBBY) is another interesting company to look at in regard to their past buyback and their current buyback. Consider how that is affecting and will affect their balance sheet. And consider what their balance sheet would look like if they bought back one quarter of their stock for about the same price as their current buybacks.For thought, would BBBY's shareholders be better off if they used that money for cash dividends instead?Roger
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