by Floyd Brown, Advisory Panelist, Investment U
Wednesday, February 6, 2008: Issue #760
Warren Buffett is the most successful investor in modern history. Often called the “Oracle of Omaha” because of his incredible ability to achieve amazing gains in the stock market, he is the world’s wealthiest money manager and investor.
Berkshire Hathaway is Buffett’s investment vehicle. Since he took control of the company and became CEO, it has consistently outperformed the S&P 500. Berkshire has had a compounded annual gain of 21.4% versus 10.4% for the S&P 500 since 1965. The cumulative result is a whopping 361,156% gain for Berkshire versus 6,479% for the S&P 500.
The chart below, put together by Joseph B. Casey, shows what a dollar invested in Berkshire stock looked like at the end of 2006, compared to a dollar invested in the S&P. It’s an amazing story.
So while investors have been sweating bullets during the recent volatility, what has the most famous of investors been doing?
3 Stocks on Warren Buffett’s Buy List
Warren Buffett has been buying stocks, placing big bets that the market will rebound. By closely monitoring filings at the Securities and Exchange Commission (SEC), we can get a pretty good picture of Mr. Buffett’s activities. Here is what he is doing:
Here are the actual purchases made by Buffet as reported by CNBC:
Mr. Buffett is buying more Burlington Northern (NYSE: BNI), acquiring shares during the recent market weakness.
Whenever BNI shares dip below $80, he heads back to the market for more.
Buffett also has been buying financial stocks…
He’s growing his position in the Midwestern Banking powerhouse U.S. Bancorp (NYSE: USB). By the time USB announced financial results on January 15, 2008, documents showed Berkshire was the company’s largest shareholder.
Berkshire expanded its holdings in USB by 77% during the quarter ending Sept. 30, 2007. The company now owns a 3.8% stake in USB, according to Bloomberg.
Besides that, Buffett is riding to the rescue of Swiss Re (OTC: SWCEY.PK), the world’s largest reinsurance company. Berkshire, which owns General Re, one of Swiss Re’s biggest competitors, has purchased a 3% stake in the Switzerland-based insurance titan. Buffett will also take over a large chunk of Swiss Re’s future business.
The agreement allows Swiss Re to find the money it needs because the company became embroiled in the subprime mortgage market meltdown. Swiss Re has lost more than a quarter of its value since announcing it would take a large write-down on insurance for complicated mortgage derivatives.
Berkshire Hathaway will take 20% of all premiums from Swiss Re’s property and casualty insurance over the next five years in return for taking on 20% of the insurance risk. Consequently, Swiss Re can reduce its reserves, freeing up capital to deal with the crisis.
Mr. Buffett’s moves will clearly make him a long-term big winner from the credit crisis, just as he’s done in past market downturns when he acquired assets. The key to his long-term success is a strict adherence to his value-based investment philosophy…
Warren Buffett’s Investment Philosophy
Many books have been written about Buffett’s investment philosophy and that of his mentor and Columbia University professor, Benjamin Graham.
Graham’s philosophy relied on the market making pricing mistakes. It can be summarized by saying Graham bought companies because they were cheap compared to their intrinsic value. Graham believed that as long as the market undervalued a company, he was making a good buying decision because eventually the market would realize the mistake and correct the share price, thus bringing it in line with the intrinsic value of the business.
Buffett has modified Graham’s philosophy…
He added some questions beyond share price vs. intrinsic value computations. These questions are summarized below, and any investor should be able to answer them before buying shares in any firm. This list was prepared by Warren’s ex-daughter-in-law, Mary Buffett, for her excellent book Buffettology.
- Is the company in an industry with good economics, i.e., not an industry competing on price? Does the company have a consumer monopoly or brand name that commands loyalty? Can anyone with an abundance of resources compete successfully with the company?
- Are the Owner Earnings on an upward trend with good and consistent margins?
- Is the debt-to-equity ratio low, or is the earnings-to-debt ratio high, i.e. can the company repay debt even in years when earnings are lower than average?
- Does the company have high and consistent returns on invested capital?
- Does the company retain earnings for growth?
- The business should not have high maintenance cost of operations, high capital expenditure or investment cash outflow. This is not the same as investing to expand capacity.
- Does the company reinvest earnings in good business opportunities? Does management have a good track record of profiting from these investments?
- Is the company free to adjust prices for inflation?
Warren Buffett also concentrates when he buys. For its size, Buffet’s portfolio has few stocks. To make additions to the portfolio, he will wait years for a market correction. But once a downturn comes, he will buy millions of shares of solid businesses at reasonable prices.
So if you are on the sidelines, maybe you should ask yourself why America’s most successful investor isn’t.
Floyd Brown, a regular contributor to Investment U, began his highly successful investing career while still in high school… and made his first million before turning 30. To see what else he’s recommending, here are the five energy picks he made last month.
Today’s Investment U Crib Sheet – Calculating “Graham’s Number”
- There’s a reason Warren Buffett’s mentor is considered one of the world’s greatest investors…After the 1929 stock-market crash, and during the Great Depression of the 1930s – perhaps the worst bear market ever – Graham averaged returns of 17% a year. And during the great bear market from 1971-1982, the average annual return on stocks meeting Graham’s “value” criteria was 33.7% a year, according to one study.
- What was his secret to picking winners? Take a look at Investment U Issue #658, Grahams Number… How to Calculate and Use This Classic Metric to Make Yourself a Bundle, and find out how to calculate “Graham’s Number.”
- Of course, picking stocks is only half the battle. Successful investors who win year in and year out are also stellar money managers. In other words, they not only know what to buy, but how much to buy… and when to sell. To find out how to master money management, see our free report – The Two Most Profitable Secrets of the World’s Greatest Investors.