Aside from what they are buying and selling, Warren Buffett and Charlie Munger are quite clear about how they invest. Over the years, the collective writings of these two investors have yielded some of best investing lessons ever. And rather than try and summarize their ideas and philosophies, I'll do all of us a favor and let Buffett and Munger speak for themselves. After all, they have a unique ability to break down complex problems to their basic essence.
In the 1992 Berkshire Hathaway (NYSE: BRKA) annual report, Buffett and Munger offered readers some magnificent insights into the minds of two of the world's greatest business thinkers.
Evaluate the business in its entirety
It should come as no surprise that Buffett likes to stick to what he knows and to keep things simple:
Our equity investing strategy remains little changed from what it was fifteen years ago, when we said in the 1977 annual report: "We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want businesses to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price."
We have seen cause to make only one change in this creed: Because of both market conditions and our size, we now substitute "an attractive price" for a "very attractive price."
Buffett went on to explain the folly of thinking that value investing and growth are opposing strategies.
But how, will you ask, does one decide what's "attractive"? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: "value" and "growth." Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing. We view this as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago).
Buffett's "confession" refers to his pure Ben Graham-style investing during the early partnership years, when Buffett was famous for not paying more than two or three times book value for any company. This strategy was effective for a while, but thanks to Charlie Munger, Buffett realized that it was OK to pay a fair price for a great company versus only paying a great price for any company. Hence the purchase of See's Candies in the 1970s and the big investment in Coca-Cola (NYSE: KO) in the 80s.
Buffett continues:
In our opinion the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
On value investing, he says,
In addition we think the very term "value investing" is redundant. What is investing if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value -- in the hope that it can soon be sold for a still-higher price -- should be labeled speculation (which is neither illegal, immoral nor -- in our view -- financially fattening).
So as Charlie Munger has said, "all intelligent investing is value investing."
Indeed, Ben Graham defined investing as an operation based on three characteristics: research and analysis, presence of an adequate margin of safety, and a satisfactory return on your investment. All of Buffett's investments have cleared these hurdles, whether it was Wells Fargo (NYSE: WFC) in the 1990s or Burlington Northern Santa Fe (NYSE: BNI).
I will delve deeper into this annual report in a follow-up. Until then, give our related Foolishness a try:
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