Warren Buffett of Berkshire Hathaway Inc.: How to Avoid Ruining a Decade's Worth of Success

Finding a great company is only the first or two steps in Warren Buffett's approach to investing.

Jul 21, 2014 at 7:00AM


"The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do. For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments."

- Warren Buffett (1982)

There's a viable argument that Warren Buffett's success at the helm of Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) was the result of luck and not, as others claim, his contrarian approach to investing, logic-based temperament, or prescience about the market's ebbs and flows.

"I am not saying that Warren Buffett is not skilled," Nassim Taleb wrote in the preface to Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, "only that a large population of random investors will almost necessarily produce someone with his track records just by luck."

The problem with this line of argument is that it relies on quantitative measures of performance -- his "track record." By doing so, it excludes the more qualitative analysis of the Buffett's decades of superior performance that emerges from his annual letters to shareholders. To appreciate how the latter changes the equation, Buffett's observation about "too-high purchase price[s]" in 1982 are a revealing place to start.

1982: A watershed moment for the market
The year 1982 was a watershed moment for equities. The Federal Reserve had succeeded at breaking the back of double-digit inflation. Stocks set off on a rally that would culminate in the "most extraordinary bull run in U.S. history." And a corporate acquisition frenzy got under way thanks to "junk bonds" peddled by the since-disgraced financier Michael Milken.

It's with the final development in mind that Buffett referred in his shareholder letter, written in March of the following year, to the "Acquisition Follies of 1982."

In retrospect, our major accomplishment of the year was that a very large purchase to which we had firmly committed was unable to be completed for reasons totally beyond our control. ... Had it come off, this transaction would have consumed extraordinary amounts of time and energy, all for a most uncertain payoff.

Buffett's opinion on this couldn't have been more contrarian. The impetus for the budding craze came when a small consortium of investors, spearheaded by former U.S. Treasury Secretary William E. Simon, purchased Gibson Greeting Cards for $80 million in January of 1982.

While the deal seemed simple enough at first glance, a deeper analysis revealed that the investors contributed a mere $1 million of their own money, financing the remainder by leveraging Gibson Greeting's assets. Fast forward 16 months, Simon's group took the company public in a $290 million initial public offering, reaping a 200-fold profit for the investors.

"Their phenomenal gain instantly became legend," wrote David Carey and John Morris in King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone. And thus began a frenzied decade of leveraged buyouts that would send equity prices soaring, contribute to the largest single-day market crash of all time, culminate in the criminal conviction and subsequent bankruptcy of a leading Wall Street investment bank, and result in jail time for multiple leading financiers.

Buffett on over-paying for acquisitions
It's with this as a backdrop that Buffett discussed the dangers of paying too much for an acquisition. "For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments," he wrote in his 1982 letter to shareholders of Berkshire Hathaway.

That Buffett recognized the budding trend in its infancy is a testament to both his disciplined approach to investing and his physical separation from New York, the then-epicenter of irrationality and global finance. And more than this, his observation about paying too much for even a good company rounded out his investment philosophy and transformed it into a two-part analysis that anyone can adopt.

The first step is to identify great companies with durable competitive advantages. "We continually search for large businesses with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements," Buffett wrote nearly a decade later. "Charlie [Munger] and I are simply not smart enough to get great results by adroitly buying and selling portions of far-from-great businesses."

The second step, to Buffett's point in 1982, is to ensure that one does not overpay for the right to own such companies, as doing so can "undo the effects of a subsequent decade of favorable business developments."

The Foolish takeaway
There is and will ever be only one Warren Buffett. But that doesn't mean savvy and disciplined investors shouldn't try to emulate his approach. By breaking it down into an analysis both of the company itself and the value of its stock, he's charted a path that even the most recreational of investors can follow.

Warren Buffett: This new technology is a "real threat"
At the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion. Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a FREE investor alert on the company we're calling the "brains behind" the technology.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information