Tuesday, January 2, 2007

Style Of Investment

MOST people would know that Warren Buffett is one of the world's richest men. Most would also know that he is easily the most successful investor the world has ever witnessed.
As a result, many of us would like to know his secret in investing and what makes him so successful. Many of us would like to emulate him, if not in terms of investment performance, then, at least in terms of investing style.
Many have the impression that Buffett must be very smart to have done so well. To have succeeded over such a long period, he is certainly smart. And yet in another sense, he is not that smart. Buffett has said that you do not need to have the IQ of Einstein or understand complex mathematical formulae in order to invest successfully. Compared with his mentor Benjamin Graham, or vice-chairman of his company Charlie Munger, he did not invent a new investment approach nor was he a founder of an investment theory.
Buffett is not smart in that sense. It was Graham, with his famous investment text “Security Analysis”, written in 1934, who created fundamental analysis. Buffett read it and has gained immensely from it. It was from another of Graham's books, “The Intelligent Investor”, written in 1949, that Buffett learned the central investment concept of “margin of safety”. It was Graham who started value investing. By following Graham’s investment philosophy, Buffett became very successful. But as time went by, Buffett was smart enough to recognise the inadequacies of what Graham had taught him. This realisation did not come easily nor did it dawn on him out of the blue.

Warren BuffettGraham focused on investing in a stock that has an intrinsic value of RM1.00 and selling at 50 sen per share. It is this difference between the intrinsic value and the market price that determines the margin of safety that an investor looks for when investing in a stock. To Graham, the asset value of a company is important in calculating a company’s intrinsic value. To him, the balance sheet strength of a company is vital. This can be simply explained by the fact that he was writing “Security Analysis” in the depths of the Great Depression during which individual and corporate bankruptcies were the norm rather than the exception. Graham’s value investing was rather mechanical and essentially quantitative in approach. It was Munger, whom Buffett met in 1959, who helped transform Buffett from a strict Grahamite to what he is today.
Munger convinced Buffett that there is more to investing than just buying a share at 50 sen against its intrinsic value of RM1.00. While both Munger and Graham would start with the accounting figures, Munger would go beyond that. As he advised: “We’ve got to understand the accounting and the implications of the accounting and understand it thoroughly.” Besides assessing the direction of the general business climate of a particular business, Munger would also assess the quality of management and how a company is run.
One of the most important investment concepts that Buffett learned from Munger was to be able to identify a good business and invest in such a business at a reasonable price.
A good business is one which has a strong franchise, above average returns on equity or capital employed, a relatively small need for capital investment and a business that throws off cash. Munger advised that “the difference between a good business and a bad business is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time.” Munger taught Buffett the value of great franchises and the benefit of qualitative analysis, as opposed to Graham’s strictly quantitative style focusing exclusively on tangible assets. With Munger’s coaching, Buffett realised that “when you find a really good business run by first-class people, chances are a price that looks high isn’t high. The combination is rare enough; it’s worth a pretty good price.” Hence his huge investments in stocks like Coca-Cola in 1988 although Coca-Cola was not cheap by conventional standards.
Although there are significant differences between the two, it was Graham and Munger who introduced Buffett to the central concepts of value investing. But it is to Buffett’s credit that he was able to move away from a strictly Grahamite style while the other value investors have remained in the traditional Graham mindset. It is to Buffett’s credit that he was convinced by Graham and Munger’s investment logic and rational instead of charting the modern portfolio theory mumbo-jumbo. He was smart enough to know that he had much to benefit from Graham and offered to work for him free of charge and pestered Graham for three years until he was employed. In the run-up to the technology bubble, Buffett had the genius to recognise his circle of competence, stayed within that boundary and avoided the technology stocks even though Bill Gates is his buddy. Graham stressed a diversified portfolio and would sell when a stock reaches its intrinsic value. Buffett, like Munger, has a very focused portfolio and would hold the stocks for a long time. At the end, Buffett was smart enough to pick up the right things from the right people.
Can we apply the Buffett-Graham-Munger approach to Bursa Malaysia? Yes, except that one has to be very patient, disciplined and do the necessary homework. For whatever reasons, many claim to be a follower or non-follower of Buffett without really knowing his philosophy and methodology.
Many investors have blamed the Bursa Malaysia for losses or poor returns. Many have said that the Buffett-Graham-Munger investing style cannot be successfully applied to Bursa. Many investors do not realise that the real culprit of their losses or poor performance is themselves. Do not get us wrong. i Capital is not saying that Bursa and the listed companies are perfect. There is an endless list of things that can be improved and there are plenty of companies (probably the majority of them) that do not deserve an inch of support from genuine investors. But part of the fault also lies with the investing style of investors. Have they ever asked how they would perform if they had used the same method and invested in Tokyo, London or New York? Would they have the patience or the discipline?
i Capital hopes this week’s article would be beneficial to those who are or who want to be serious investors. By sharing these insight, i Capital hopes that everyone would have some of the early advantages that Buffett had. MOST people would know that Warren Buffett is one of the world's richest men. Most would also know that he is easily the most successful investor the world has ever witnessed.
As a result, many of us would like to know his secret in investing and what makes him so successful. Many of us would like to emulate him, if not in terms of investment performance, then, at least in terms of investing style.
Many have the impression that Buffett must be very smart to have done so well. To have succeeded over such a long period, he is certainly smart. And yet in another sense, he is not that smart. Buffett has said that you do not need to have the IQ of Einstein or understand complex mathematical formulae in order to invest successfully. Compared with his mentor Benjamin Graham, or vice-chairman of his company Charlie Munger, he did not invent a new investment approach nor was he a founder of an investment theory.
Buffett is not smart in that sense. It was Graham, with his famous investment text “Security Analysis”, written in 1934, who created fundamental analysis. Buffett read it and has gained immensely from it. It was from another of Graham's books, “The Intelligent Investor”, written in 1949, that Buffett learned the central investment concept of “margin of safety”. It was Graham who started value investing. By following Graham’s investment philosophy, Buffett became very successful. But as time went by, Buffett was smart enough to recognise the inadequacies of what Graham had taught him. This realisation did not come easily nor did it dawn on him out of the blue.

Warren BuffettGraham focused on investing in a stock that has an intrinsic value of RM1.00 and selling at 50 sen per share. It is this difference between the intrinsic value and the market price that determines the margin of safety that an investor looks for when investing in a stock. To Graham, the asset value of a company is important in calculating a company’s intrinsic value. To him, the balance sheet strength of a company is vital. This can be simply explained by the fact that he was writing “Security Analysis” in the depths of the Great Depression during which individual and corporate bankruptcies were the norm rather than the exception. Graham’s value investing was rather mechanical and essentially quantitative in approach. It was Munger, whom Buffett met in 1959, who helped transform Buffett from a strict Grahamite to what he is today.
Munger convinced Buffett that there is more to investing than just buying a share at 50 sen against its intrinsic value of RM1.00. While both Munger and Graham would start with the accounting figures, Munger would go beyond that. As he advised: “We’ve got to understand the accounting and the implications of the accounting and understand it thoroughly.” Besides assessing the direction of the general business climate of a particular business, Munger would also assess the quality of management and how a company is run.
One of the most important investment concepts that Buffett learned from Munger was to be able to identify a good business and invest in such a business at a reasonable price.
A good business is one which has a strong franchise, above average returns on equity or capital employed, a relatively small need for capital investment and a business that throws off cash. Munger advised that “the difference between a good business and a bad business is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time.” Munger taught Buffett the value of great franchises and the benefit of qualitative analysis, as opposed to Graham’s strictly quantitative style focusing exclusively on tangible assets. With Munger’s coaching, Buffett realised that “when you find a really good business run by first-class people, chances are a price that looks high isn’t high. The combination is rare enough; it’s worth a pretty good price.” Hence his huge investments in stocks like Coca-Cola in 1988 although Coca-Cola was not cheap by conventional standards.
Although there are significant differences between the two, it was Graham and Munger who introduced Buffett to the central concepts of value investing. But it is to Buffett’s credit that he was able to move away from a strictly Grahamite style while the other value investors have remained in the traditional Graham mindset. It is to Buffett’s credit that he was convinced by Graham and Munger’s investment logic and rational instead of charting the modern portfolio theory mumbo-jumbo. He was smart enough to know that he had much to benefit from Graham and offered to work for him free of charge and pestered Graham for three years until he was employed. In the run-up to the technology bubble, Buffett had the genius to recognise his circle of competence, stayed within that boundary and avoided the technology stocks even though Bill Gates is his buddy. Graham stressed a diversified portfolio and would sell when a stock reaches its intrinsic value. Buffett, like Munger, has a very focused portfolio and would hold the stocks for a long time. At the end, Buffett was smart enough to pick up the right things from the right people.
Can we apply the Buffett-Graham-Munger approach to Bursa Malaysia? Yes, except that one has to be very patient, disciplined and do the necessary homework. For whatever reasons, many claim to be a follower or non-follower of Buffett without really knowing his philosophy and methodology.
Many investors have blamed the Bursa Malaysia for losses or poor returns. Many have said that the Buffett-Graham-Munger investing style cannot be successfully applied to Bursa. Many investors do not realise that the real culprit of their losses or poor performance is themselves. Do not get us wrong. i Capital is not saying that Bursa and the listed companies are perfect. There is an endless list of things that can be improved and there are plenty of companies (probably the majority of them) that do not deserve an inch of support from genuine investors. But part of the fault also lies with the investing style of investors. Have they ever asked how they would perform if they had used the same method and invested in Tokyo, London or New York? Would they have the patience or the discipline?

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