I have never been one to be afraid to borrow from the ‘investment masters’ to highlight a point to teach others how not to make the same mistake.
While Warren E. Buffett is extremely well followed by the financial press almost to cult-like status, (if you are fortunate enough to hold the golden ticket to one of his shareholder meetings, you’ll nod in agreement, asking price for that ticket, just north of $100,000 USD for one share in Berkshire A class shares) in investment circles, he maintains his place at the top of the investment shelf. Warren himself muses at his own popularity with the financial community.
“When I was 21 years old, I could have been saying the most brilliant things on earth and nobody would have listened to me. Now, I could say that the moon was made of pink tissue paper and everyone would go, ‘Wow, look! It really is’. And they would believe me, because I am Warren Buffett.”
Highly quoted and sought after by the press he may be, but few if any know that the greatest living source of investment wisdom, himself had his own ‘investment sage’, great mentor and friend the late Benjamin Graham.” Investing is at its best when it is most businesslike.” That’s what Ben taught us in the bible of investment books “The Intelligent Investor.” First penned in 1949, it remains in print today.
No, this time is NOT any different!
Benjamin Graham was one of Warrens professors at Columbia University Business School and considered the grandfather of the original ‘value’ versus ‘price’ investment style. Widely followed by others on the successful billionaire investor list, known as the disciples of Graham and Dodd.
Graham drew a line between speculating and investing and called the former a futile activity, he also proclaimed that ‘new eras’ to describe current market conditions were actually not new at all.
Grahams aim for investors was simple as in Buffett’s words “to set up a sound framework for investing and to stop your emotions from corroding that framework”. Simply, don’t follow the herd, profit from its folly instead, the stockmarket early March this year, case in point. That’s it? No erroneous equations, measures of relative strength or insights into structured finance??
Margin of Safety as a central concept
As well as simply understanding what the ‘value’ of something is relative to its ‘price’. Chapter 3 of “The Intelligent Investor” deals with the Margin of Safety concept relative to Intrinsic Value. Put simply, to purchase a stock (business) at a price that can allow for any mistakes in your calculation of a company’s intrinsic value, that is, its value now and into the future. This is best illustrated with an example of Buffett’s purchase in 1973 of the Washington Post.
The Post owned a wonderful collection of media assets that Buffett concluded were worth about $400 million. The company, meanwhile, was selling in the market for just $80 million. A bargain pick up? Yes. Unappreciated by the market? Yes. A satisfactory margin of safety? Definitely. Case closed.
Value is never apparent on the surface
My entire investment philosophy changed forever with one line from that famous chapter. “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” Meaning, if every man and his home boy knows that a company is going great guns and likely to return 50% in earnings per year for the next five years then that knowledge will be factored into today’s share price. If you’re looking to invest in companies that have that kind of spectacular growth potential, you have to make sure ‘that’ kind of spectacular growth potential is unappreciated.
If you would kindly replace the word ‘business’ and ‘company’ with the word ‘investment property’ and if more people understood this most basic advice you would see Warren Buffett and the whole Graham-Dodd crowd of billionaire investors, turn and run a million miles from the current Australian residential investment property market. You don’t have to be Stephen Hawking to work out there is still an incredible amount of ‘greed’ going on as well as a very, very over appreciated market.
In part 2, I will provide more tips on how we can use this for our everyday financial affairs and planning.
Nick Christian is a Financial Adviser and planner and authorised representative of Millennium3 Financial Services.
The views and opinions expressed within this letter are those of the author and do not necessarily reflect those of Millennium3 Financial Services Pty Ltd.
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
