Table of Contents
An Outstanding Investor
Growth and Expansion
Buffet’s Approach to Investment
Company Valuation: Six Key Principles
Warren Buffet, the architect and CEO of Berkshire Hathaway is one of the world’s most successful investors with unique investment principles and management culture. He is an American businessman, investor and philanthropist ranked the world’s richest man in 2008 with an estimated net worth of $62 billion. Over the past 37 years, Buffet has consistently grown Berkshire’s market value at an annual compound growth rate of over 25%, an almost impossible feat. Putting into perspective the consequences of such sustained compound growth rate for long periods, an investment of $10,000 with the company when Buffet took charge would translate more than $40 million today. Buffet’s unique principle and approach of value investing where he indentifies undervalued companies with good potential for future growth by analyzing their financial statements, makes him perhaps the most successful stock market investor of the past three decades.
Warren Buffet was born on August 30, 1930 in Omaha, as the second of three children to his father, Howard, who was a stockbroker turned congressman. Buffet showed aptitude for numbers, money, and investment at an early age. He amazingly filed his tax return at the age of 13 deducting $35 for his bike as a business expense. His interest in the Stock market was also from an early age. He purchased his first stock; Cities Services preferred shares, at the age of 11 for $38 but later sold them for $40 not speculating that the price would soon rocket to $200 within a few years. This was an invaluable lesson, as he got to understand the importance of investing in good companies for the long term (Hagstrom, 2000). Buffet graduated from Woodrow Wilson high School in 1947 and attended the Wharton Business School at the University of Pennsylvania. He returned home and transferred to the University of Nebraska-Lincoln after his father was defeated in the 1948 Congressional race and managed to graduate in three years while working full time. While a student, he read The Intelligent Investor by Benjamin Graham, a book that had such a profound influence in his outlook that he went to study at the Columbia Graduate Business School where Graham was tutoring. Being the only student who scored an A+ in Graham’s security analysis class, he was offered a job to work for Graham-Newman upon graduation but instead chose to work for his father’s brokerage firm as a sales representative (Hagstrom, 2005). While working as a salesman, he pushed for investment in GEICO stock after noticing that Graham was a director in the company. In 1954, he was recalled by Benjamin Graham and offered a job at his partnership with a starting annual salary of $12,000 (Hagstrom, 2000).
An Outstanding Investor
Warrant Buffet is the business personality of choice due to his remarkable story and principles that places him as one of the most truly inspiring entrepreneurs of all time. An entrepreneur is an individual or a team that develops, initiates and leads a venture and Warren Buffet best fit the definition. He has demonstrated an untainted, old-time approach and philosophy to initiation and acquisition of business ventures. He has been able to study various companies and market segments and continuously invested in existing companies rather than launch operations of his own. Buffet has been able, through an uncanny ability to pick winners, to use resources characteristics of utility, value and exchange to create a well-diversified portfolio of American companies (Lupo, 2008).
The personality is also greatly respected and admired by other leading entrepreneurs and business personalities. He has been able to take advantage of opportunities that others may not recognize and organize and balance resources to exploit them. Buffet has always been able to make stock-price downturns into buying opportunity; a move that has been quite successful across the years as he turns around struggling business ventures. Buffet has shown all the three fundamentals that characterize leading entrepreneurs as documented by Priestly (2013: p. 147). Leading entrepreneurs are known to do something they are passionate about, do something they are good at and do something that makes money (Priestly, 2013: p. 147). In addition to the three conditions, Buffet has shown an enormous amount of self-discipline, which is key to the success of any entrepreneurial venture. He has been able to stick to his own convictions and principles and not at any time, pushed to invest in ventures because of global trend. He scorns speculative stock market hype and prefers to buy carefully researched stocks. Buffet is the ultimate entrepreneur, knowledgeable of the markets, self-controlled, focuses on a goal, aggressive, is a risk taker, confident, has high expectations had has practical solutions to any arising problems (Tier, 2008). He carefully researches a firm’s intrinsic value and management competence, taking into account inflation and taxation considerations.
Growth and Expansion
On May 1 1956 at the age of 25, Buffet created Buffet Associates, Ltd (BPL), an investment partnership in which seven family members and friends contributed $105,000 as limited partners while Buffet put in $100 as the general partner. As per the agreement, the limited partners were to receive 6% annual interest and 75% of the profits generated above this level while Buffet was to be paid the remaining 25%. Over the next 13 years, the partnership’s investment compounded at an average annual rate of 29% and upon dissolution in 1965, Buffet cashed out with a personal stake of $25 million. With the capital, he purchased Berkshire Cotton Manufacturing, merged it with Hathaway Manufacturing, and also acquired considerable stake in two insurance companies integrating them to form Berkshire Hathaway (Hagstrom, 2005).
The integrated company generated its liquidity from its insurance division and invested extensively in stocks and bonds such that funds for payments of claims were always available upon request. By 1967, the company had a stock portfolio of $7.2 million that Buffet assumed control of and by 1969, the portfolio had grown to $42 million (Ramaswamy, 2012). In 1970, Buffet owned 29% of the outstanding stock in Berkshire Hathaway, named himself the chairman, and begun the long tradition of writing annual letters to shareholders. During the same year, the insurance, banking and investments divisions became more profitable compared to the textile operations divisions (Ramaswamy, 2012).
When stock prices began to drop considerably in 1973, Berkshire borrowed money by issuing notes at 8% and reinvesting in other companies such as the Washington Post. Nonetheless, the falling stock prices were costly to Buffet who lost 50% of his personal wealth to declining stock prices. The U.S Securities and Exchange Commission even opened a formal investigation into Buffet although no adverse findings were reported. By the late 1970s, his reputation had grown to a point that any information or rumor that he was interested in a company was enough to shoot a company’s stock prices up by 10%. By this time, its stock was trading by more than $290 per share and Buffet’s personal wealth had risen to more than $140 million even though he had never sold a single share of his company (Hagstrom, 2005).
The company’s growth was relentless, pushed by multiple intelligent strategic acquisitions. Buffet purchased Nebraska furniture mart for $60 million and the same year, had an estimated 41.3 billion corporate stock portfolio. It also started with $775 per share and ended with $1,310 and his personal net worth had grown to $620 million in 1983. Buffet decided to shut down the Berkshire textile division in 1985 and decided to purchase Scott & Fetzer, a company that sells products such as World Book Encyclopedia and Kirby vacuums, at an estimated $315 million (Hagstrom, 2000). In the following years, Buffet helped orchestrate the merger between Cap Cities and ABC in 1987 and also started aggressively acquiring Coca-Cola stock in 1988 until Berkshire owned 7% valued at $1.02 billion within the year. By 1989, Hathaway’s shares were trading at $8,000 and Buffet’s personal wealth was estimated at $3.8 billion dollars (Hagstrom, 2005).
The company’s stock grew to as high as $80,000 per share in the 1990s even though Buffet was continuously accused of losing touch as the dot-com frenzy began to take hold. He was, however, unmoved and continued to allocate capital to great businessess that was selling below their intrinsic value. Despite the company’s shares falling to around $45,000, steadfastness and consistency saw the stock recover and stabilize in the early 2000. In 2002, Buffet was awarded an$11 billion contract to deliver US dollars against other currencies, a contract that earned him $600 million by December 31, 2003 (Lupo, 2008).
Warren Buffet’s main investment methodology is a hybrid of strategies put forward by leading investment scholars, Ben Graham and Philip Fisher. Many consider Benjamin Graham, the author of two leading books The Intelligent Investor and Security Analysis, the first professional financial analyst. His investment policy was to focus on acquiring well-chosen diversified portfolio of common stock based on sound analysis and reasonable pricing. Graham defines an investment as one based on through analysis and which promises safety of principal and satisfactory return (Lupo, 2008). He therefore describes fundament investment approaches, which include; the cross-section approach, the anticipation approach that comprises both short-term selectivity and growth stocks and the margin safety approach. The cross-section approach stipulates that an investor should buy some shares in companies in nearly every sector of the market. This is a safe move since whatever happens in the economy, at least one of the stock will end up performing well (O'Loughlin, 2003).