Pick Stocks Like Warren Buffett
By Warren Boroson

Contents

Introduction: What Investors Can Learn from Warren Buffett vii
1 It’s Easy to Invest like Warren Buffett
2 The Achievement of Warren Buffett
3 Buffett: A Life in the Stock Market 1
4 The Influence of Benjamin Graham
5 The Influence of Philip Fisher
6 How Value and Growth Investing Differ
7 Buffett’s 12 Investing Principles
8 Don’t Gamble
9 Buy Screaming Bargains
10 Buy What You Know
11 Do Your Homework
12 Be a Contrarian
13 Buy Wonderful Companies
14 Hire Good People
15 Be an Investor, Not a Gunslinger
16 Be Businesslike
17 Admit Your Mistakes and Learn from Them
18 Avoid Common Mistakes
19 Don’t Overdiversify
20 Quick Ways to Find Stocks That Buffett Might Buy
21 William J. Ruane of Sequoia
22 Robert Hagstrom of Legg Mason Focus Trust
23 Louis A. Simpson of GEICO
24 Christopher Browne of Tweedy, Browne
25 Martin J. Whitman of the Third Avenue Funds
26 Walter Schloss of Walter & Edwin Schloss Associates
27 Robert Torray of the Torray Fund
28 Edwin D. Walczak of Vontobel U.S. Value
29 James Gipson of the Clipper Fund
30 Michael Price of the Mutual Series Fund
31 A Variety of Other Value Investors
32 Putting Everything Together
Appendix 1 Wanted: Cheap, Good Companies
Appendix 2 Berkshire Hathaway’s Subsidiaries (2000)
Appendix 3 Quotations from the Chairman
Appendix 4 “65 Years on Wall Street”
Appendix 5 Martin Whitman on Value Versus Growth
Appendix 6 A Weekend with the Wizard of Omaha: April 2001
Appendix 7 “If You Own a Good Stock, Sit on It.”—Phil Carret
Glossary
Index

Sample Pages

Introduction: What Investors Can Learn from Warren Buffett

Berkshire Hathaway’s stock has risen nearly 27 percent a year for the past 36 years. For its consistency and profitability, this company, managed by Warren E. Buffett of Omaha, has been amazing.

If you asked Buffett how you, as an individual investor, could go about imitating his spectacularly successful investment strategy, his answer would be: buy shares of Berkshire Hathaway. He happens to be an unusually sensible person, and that is clearly the best answer.

But if you buy or intend to buy other stocks on your own, either one-at-a-time or through a managed mutual fund, there is much that you can learn by studying Buffett’s tactics.

Why not just do the obvious and put all your money into Berkshire Hathaway stock? One reason: It’s mainly an insurance holding company - Buffett is an authority on insurance. Because of this, the stock has virtually no exposure to many areas of the stock market, such as technology and health care. A second reason: Berkshire has become so enormous that its future performance is handicapped, much like the odds-on favorite in a horse race being forced to carry extra weights.

In short, you might do better on your own. First, because you have a smaller, more nimble portfolio. And, second, because you might shoot out the lights by overweighting stocks in whatever field you’re particularly knowledgeable about - health care, technology, banking, whatever. Buffett refers to this as staying within your “circle of competence.” (There’s nothing wrong, of course, with your also buying Berkshire stock. I have. The Sequoia Fund, run by friends of Buffett’s, has one-third of its assets in Berkshire.)

While the average investor can learn a thing or two from the master, he or she simply cannot duplicate Buffett’s future or past investment performance. One obvious reason: Buffett has the money to buy entire companies outright, not just a small piece of a company. He also buys preferred stocks, engages in arbitrage (when two companies are merging, Buffett may buy the shares of one, sell the shares of the other), and buys bonds and precious metals. He’s also on the board of directors of a few companies Berkshire has invested in. Perhaps the most difficult thing for individuals to duplicate is Buffett’s small army of sophisticated investors around the country who fall all over themselves to provide him with “scuttlebutt” about any company he’s thinking of buying. Also, Buffett has the word out to family-owned businesses: “I’ll buy your company and let you keep running it” (another thing individuals can’t duplicate).

Let’s not forget, too, that Buffett also happens to be extraordinarily bright, a whiz at math, and to have spent his life almost monomaniacally studying businesses and balance sheets. What’s more, he has learned from some of the most original and audacious investment minds of our time, most notably Benjamin Graham.

Still, while it’s true that trying to emulate Pete Sampras or the Williams sisters does not guarantee that you will wind up in Wimbledon, you could very likely benefit from any of the pointers they might give—or from studying what it is they do to win tennis matches.

Buffett has often said that it’s easy to emulate what he does, and that what he does is very straightforward. He buys wonderful businesses run by capable, shareholder-friendly people, especially when these businesses are in temporary trouble and the price is right. And then he just hangs on.

There is, in fact, a whole library of books out there about Buffett and his investment strategies. There are Berkshire web sites, Internet discussion groups, and annual meetings that are beginning to resemble revival meetings. There is also a Buffett “workbook” that helps people invest like Warren Buffett. It even includes quizzes.

This book isn’t written for the Chartered Financial Analyst or the sophisticated investor (readers familiar with Graham and Dodd’s Security Analysis). It is for ordinary investors who know that they could do a lot better if they knew a little more. And the truth is, much of Buffett’s investment strategy is perfectly suited for the everyday investor. His advice, which he has been generous in sharing, is simple and almost surefire.

Buffett buys only what he considers to be almost sure things - stocks of companies so powerful, so unassailable, that they will still dominate their industries ten years hence. He confines his choices to stocks in industries that he is thoroughly familiar with. He will seek out every last bit of information he can get, whether it’s a company’s return on equity or the fact that the CEO is a miser who takes after Ebenezer Scrooge himself. He scrutinizes his occasional mistakes, quickly undoes them, and tries to learn lessons from the experience. While he is loyal to the management and employees of companies he buys, he is first and foremost loyal to his investors. To Warren Buffett, the foulest four-letter word is: r-i-s-k.

Beyond that, he avoids making the mistakes ordinary investors make: buying the most glamorous stocks when they’re at the peak of their popularity; selling whatever temporarily falls out of favor and thus following the crowd (in or out the door); attempting to demonstrate versatility by buying all manner of stocks in different industries; being seduced by exciting stories with no solid numbers to back them up; and tenaciously holding onto his losers while shortsightedly nailing down the profits on his winners by selling.

In short, as Buffett has modestly confessed, the essential reason for his success is that he has invested very sensibly and very rationally.

Another way of putting it: Buffet invests as if his life depended on it.

A word of warning: Not all of Buffett’s strategies should necessarily be imitated by the general investing public, in particular Buffett’s penchant for buying only a relatively few stocks. A concentrated portfolio, in lesser hands, can be a time bomb.

There are some things that geniuses can (and should) do that lesser mortals should be wary of; there’s a law for the lion and a law for the lamb. Ted Williams, the great baseball slugger, never tried to bunt his way onto first base, even during the days of the “Williams Shift,” when players on the opposing team moved far over to the right side of the field to catch balls that Williams normally whacked down that way. He wasn’t being paid to bunt toward third base and wind up with a mere single, much the way Warren Buffett isn’t expected to do just okay. But you and I, not being quite in the same class as those two, should be perfectly content with getting on base consistently using such unimpressive techniques as bunt singles.

No doubt, overdiversification—owning a truckload of different securities—is something that gifted investors should steer clear of. But underdiversification, owning just a few securities, is something that ungifted investors (in whose ranks I happily serve) should also avoid like the plague.

In 1996 there appeared a short, charming book with a cute title: Invest Like Warren Buffett, Live Like Jimmy Buffett: A Money Manual for Those Who Haven’t Won the Lottery (Secaucus, NJ: Carol Publishing Group, 1996). The author is a Certified Financial Planner, Luki Vail.

The text talks about the blessings of an investor’s owning a diversified portfolio, not a concentrated portfolio. Writes the author, “Diversification of your investment dollars along with appropriate time strategies are your best tactics to protect you against such things as stock market crashes.” (“Time strategies” means suiting your portfolio to your needs. If you think you’ll need your money in fewer than five years, go easy on stocks.)

Why buy mutual funds? “Here is your chance to own stocks in 50 to 75 companies.”

“Generally, stay away from individual stocks until you have about $250,000 to invest; then you can have a well-diversified portfolio, like your own personal mutual fund. That way when a stock takes a nose dive on you, it will only have a small position in a very large portfolio, and you will take only a small loss, which could possibly be offset by the gain of some other stock.”

In brief, she is recommending that readers of her book not swing for the seats but bunt for singles. That’s no doubt sensible counsel for her readers, but it is not the Warren Buffett way.

I might offer a compromise suggestion: The ordinary investor, the lesser investor, might have a core portfolio of large-company index funds composing 50 percent or more of the entire stock portfolio. (Buffett has recommended that tactic for most investors.) And outside the core portfolio, the lesser investor might swing for the seats by imitating the strategy of the man generally acknowledged to be the greatest investor of our time.

Warren Boroson
Glen Rock, N.J.

Chapter 1

It’s Easy to Invest like Warren Buffett

Buying shares of Berkshire Hathaway is the easiest way to invest like Warren Buffett. While the A shares cost around $70,000 apiece as of this writing, the B shares sell for only around $2,300 each - roughly 1/30 of the A shares. The B shares do have their disadvantages. For example, holders have less in the way of voting rights and aren’t entitled to indicate where Berkshire charitable contributions go. (Berkshire is unusual in allowing shareholders to recommend how Berkshire’s charity money should be allocated.) And while you can convert A shares into B, it doesn’t work the other way around.

Which to buy? Berkshire is nothing if not shareholder friendly, and Buffett has given this advice: Buy the A shares, if you can afford them, unless the B shares are trading cheaply. “In my opinion, most of the time the demand for B will be such that it will trade at about 1/30 of the price of the A. However, from time to time, a different supply-demand situation will prevail and the B will sell at some discount. In my opinion, again, when the B is at a discount of more than, say, 2 percent, it offers a better buy than A. When the two of them are at parity, however, anyone wishing to buy 30 or more B should consider buying A instead.”

An investor might dollar-cost-average into Berkshire’s B shares using a discount broker. So, for example, in order to build a $13,200 position, he or she might buy two shares six times a year. Or, if the buyer is less patient, two shares for three straight months. It is also a good idea to check whether two leading newsletters,

It is also a good idea to check whether two leading newsletters, The Value Line Investment Survey and Standard & Poor’s “The Outlook,” give the stock a decent rating at the time of purchase, and perhaps either wait a bit or buy energetically depending on their views. (Hardly any other analysts cover Berkshire.) As of this writing, Value Line rated Berkshire, at $70,000 a share, average; “The Outlook” - whose Berkshire analyst, David Braverman, is probably the very best - above average.

Another guide: Consider whether the stock is closer to its yearly high or low. Buying Berkshire low is certainly appropriate for someone intending to be a follower of Warren Buffett’s value-oriented investment strategy.

Buying Individual Stocks

Another practical possibility for Buffett followers is to buy the publicly
traded stocks that Berkshire owns—like Coca-Cola, Gillette,
H&R Block, and General Dynamics. (Berkshire is also the sole
owner of various companies, like See’s Candy and GEICO, the insurance
company, but these companies are not publicly traded.) Because
of Buffett’s history of purchasing reasonably priced stocks,
these stocks should still be worth buying.

A danger, of course, is that Berkshire may have begun unloading
those stocks, the way it began quietly bailing out of Disney in 2000,
as you are just beginning to purchase them. Another danger is that
your portfolio will be askew: You will have more exposure to certain
stocks and industries than Berkshire itself has. As a result, your
portfolio might be a riskier version of Berkshire.

You can balance out your Buffett-like portfolio with stocks from
the holdings of mutual funds that invest roughly the way Buffett
does, such as Sequoia, Tweedy, Browne Global Value and American
Value, Legg Mason Focus Trust (omitting from the last any technology
stocks, which Buffett tends to avoid), Third Avenue Value, Clipper,
Longleaf Partners, Torray, and Vontobel U.S. Value. You can
examine a list of these funds’ recent holdings either by going to their
web sites or by consulting Morningstar Mutual Funds, a newsletter
to which most large libraries subscribe. The list of holdings will be
somewhat outdated, but, again, most of these value stocks should
remain reasonably priced.

You might also balance your portfolio by concentrating on stocks
in industries outside the ones you already have covered in your Buffett-
like portfolio, along with foreign stocks, which Buffett also
tends to avoid. For suggestions of foreign stocks to buy, check those
in the portfolio of Tweedy, Browne Global Value.

For U.S. stocks, I would single out health-care stocks because
Berkshire has tended to ignore this entire industry, perhaps because
the stocks have almost always been high-priced or because they are
outside Buffett’s “circle of competence.”

You can also balance out your Buffett-like portfolio with stocks
chosen from the list compiled at Quicken.com by Robert
Hagstrom. He derives this list using his criteria for picking Buffetttype
stocks, Hagstrom being an authority on Buffett’s strategy.
(See Chapter 20.)

For more on Sequoia, see Chapter 21; for Legg Mason Value Trust,
Chapter 22; for Tweedy, Browne, Chapter 24; for Third Avenue
Value, Chapter 25; for Torray, Chapter 27; for Vontobel, Chapter 28;
and for Clipper, Chapter 29.

Buying Buffett-like Mutual Funds

Instead of buying individual stocks, you could buy one or more Buffett-like mutual funds—in effect, having someone else buy Buffetttype stocks for you. Even granting that Buffett is in a class by himself, cheap imitations—cheap in the sense of your being able to buy many shares for a low minimum—aren’t to be sneezed at. These funds, in some cases, do not deliberately emulate Buffett’s strategy. For example, Third Avenue Value, under Martin J. Whitman, doesn’t. Others, to a certain extent, do—notably, Sequoia, Tweedy, Browne American Value, Legg Mason Focus Trust, Torray, Longleaf Partners, and Vontobel U.S. Value.

Which fund most resembles Berkshire? No doubt Sequoia, which was started by a Columbia Business School friend of Buffett’s and which invests a big chunk of its assets in Berkshire. (Unfortunately, Sequoia is closed to new investors.) Table 1.1 shows Sequoia’s recent holdings.

Sequoia suffered a dismal 1999, along with Berkshire itself and with many other value funds. But its long-term record is splendid. Over the past 10 years it has outperformed the S&P 500 by 2.31 percentage points, returning 17.56 percent a year.

Which of the other funds most resembles Sequoia? Buffett has reportedly said that the Clipper Fund is close to his investing style.

A lesser-known fund that has much in common with Berkshire is Vontobel U.S. Value, run by Edwin Walczak. He readily acknowledges Buffett’s influence; his portfolio recently had a 5 percent exposure to Berkshire, its fifth largest position. Other stocks in Walczak’s portfolio that have overlapped with Berkshire: Mercury General, Gannett, McDonald’s, Gillette, Wells Fargo. The fund is classified by Morningstar as mid-cap value.

Note: The rest of this chapter is omitted