Warren Buffett was, for several years, the richest person in the world. How did he become so wealthy? Shrewd investing. Early investors in his limited investment partnership Berkshire Hathaway (BRKA) are millionaires many times over. And Buffett is a multi-billionaire.
Foundation
Buffett studied under legendary value investor Benjamin Graham. And got an A+. Graham admonished students to buy a diversified portfolio of “cheap” companies. His favorite technique was to buy stocks selling for 2/3 of their net working capital.* Graham referred to these discarded stocks as “cigar stubs.” Stocks with a few more “puffs” left in them. Graham’s quantitative approach appealed to Buffett. But, unlike Graham, Buffett didn’t diversify. Instead, he focused on his best ideas.
In 1962 Buffett took a significant position in Berkshire Hathaway, a textile company selling for half its working capital. Initially, Buffett ran the company but the task didn’t suit him well. Charlie Munger, philosopher king and Buffett’s alter ego, helped Buffett find a great manager to run the mills. While Buffett kept a tight rein on expenses to ensure a profit. But no amount of management could change the poor economics of the domestic textile industry. A lesson Buffett would never forget.
Enlightenment
About a year after his Berkshire purchase, Buffett began to buy the stock of American Express (AXP). An unrelated AXP subsidiary had become embroiled in an accounting scandal. And AXP’s share price was falling. But unlike Berkshire, it never became cheap by accounting standards. In fact, Buffett’s purchase of AXP represented a paradigm shift in his thinking. It had relatively few hard assets. Instead, AXP’s value was in its franchise and earnings growth potential.
AXP was at the forefront of the “cashless” revolution of the late 50’s and early 60’s. Almost everyone used American Express Traveler’s Checks. And with 80% market share, AXP dominated the growing charge card business. AXP generated lots of cash and required little in the way of capital investment. In short, American Express possessed a world-class franchise likely to produce significant earnings growth for many years to come. Over the next year or so, Buffett built a large position in AXP at depressed prices.
American Express vaulted from $35 in early 1964 to $180 in 1967. At its peak, AXP represented 40% of the partnership’s assets. Buffett still holds AXP today.
Invest like the master
Buffett’s approach to investing is straightforward; Buy a few great companies at depressed prices and hold. Want to know which stocks Warren’s Berkshire Hathaway holds? Here’s a link to a recent SEC FORM 13F filing. Interested in reading his annual letters to shareholders?
For investors without the time or inclination to attempt to emulate Buffett, investing in broad based, low cost stock index funds makes sense.