Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) Chairman Warren Buffett has racked up market-beating returns by buying stocks on the cheap, right? Not so fast says Georgetown University McDonough School of Business professor Prem Jain, author of Buffett Beyond Value: Why Buffett Looks to Growth and Management When Investing. I recently talked with Jain about Buffett's investing philosophy. This transcript has been edited for clarity.
Mac Greer: A lot has been written about Buffett and his investing. What is the big misconception when it comes to Warren Buffett and his investing?
Prem Jain: People think of Buffett as if he was basically a duplicate of Benjamin Graham, in the sense that he reads the financial statements; examines numbers such as price-to-earnings ratio, price-to-book ratio, and other metrics; and invests using the so-called buy low, sell high paradigm. I think that is a misconception. He himself has said that it is better to buy a good company at a fair price. Consider his purchases, especially the latest $36 billion purchase of Burlington Northern Santa Fe. He seems to have paid at least a fair price in the sense that he paid [a] price-to-earnings ratio of 18.
So this whole idea that he is a value investor alone is a misunderstanding once we examine the way he invests. He is a value investor in the sense that he focuses a lot on the downside risk -- as he has said a couple of times, rule No. 1, you should not lose money, and that is a very important aspect of value investing. But that is not all he does. It is very important to realize that the companies in which he has invested have generally grown fast. So, he is looking for companies that are likely to grow in the future, and his valuation is not based just on the current price-to-earnings ratio or the current-price-to-assets ratio or the current-price-to-book ratio. He himself says that he is 85% Benjamin Graham and 15% Philip Fisher, Philip Fisher being a growth investing guru.
I think that people seem to consider him to be stuck on the value concept rather than the growth concept. However, as time has progressed in the last 50 years or so, he has been focusing a lot more on growth than people realize.
Greer: And Prem, you also point out that his earlier investments in Coca-Cola (NYSE: KO), American Express (NYSE: AXP) and Wells Fargo (NYSE: WFC) weren't cheap either, so this is more about Buffett buying at a reasonable valuation, but not necessarily a low valuation?
Jain: Correct. He buys at reasonable valuations. That is one of the first items that I noticed. And then I started investigating how he earns high returns. Because if you are going to buy something at a reasonable valuation, the folklore is that you are then going to earn reasonable returns, but he earns high returns. I came to the conclusion that he buys companies or stocks at reasonable valuations, but there is something unique about those companies and they produce high returns.
And the unique [thing] about those companies is that the management is excellent so that these companies, even though they are in traditional industries, produce high returns. And that is what he does.
The lesson for an investor is that to earn high returns, it is important to understand a company's past well and it is also important to understand the company's future and its management. In other words, one should stick to what one knows. One can then look into the future more clearly and better understand how these companies are going to turn out.
Greer: Prem, how do you invest your money?
Jain: Well, I have invested more and more, first of all, with Buffett. Right now, I have 50%+ of my net worth, which is other than the retirement money, in Berkshire Hathaway. During the last 15 to 20 years, whenever I found a company that was similar to Buffett's company, I have invested heavily. I will give you one example, if you want. Wal-Mart (NYSE: WMT) is a highly successful company. I never invested in Wal-Mart, really, because every time I looked at it, somehow or other I felt that OK, I missed it. But then what happened was I was traveling in Mexico and I saw Wal-Mart there, and I later found out that Wal-Mart in Mexico is not 100% owned by Wal-Mart, but is only partially owned by Wal-Mart, and its shares are available both in the U.S. and in Mexico. And I invested heavily in Wal-Mart de Mexico (WMMVY.PK). It has given me very high returns.
And there are some other companies I have invested similarly. When I find a company I am interested in, I invest a little bit in it first, then I go to the annual shareholders' meeting and I read about the company a lot. I do ground research in the sense that I will go and visit their stores if they are in retailing and then if I find that the company is incredibly good, I invest more.
Looking for other Coca-Cola-type companies with Buffett-type qualities? Check out "Warren Buffett Wants Stocks Like This and So Do I."
