Fin 4201/8001
Topic 2: The Three Wise Men
WB – Philosophy
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Investment selection
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“The best way to hit a home run: Don’t swing
at everything; wait for a fat pitch.”
“You find these well-smoked, down-to-thenub cigars, but they’re free. You pick them
up and get one free puff out of them.
Anything is a buy at a price.”
Portfolio management
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“The best way to outperform the market:
Don’t load up on hundreds of stocks;
WB – Philosophy
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On Ben Graham
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“(Graham) wasn’t about brilliant investments and he
wasn’t about fads or fashion. He was about sound
investing, and I think sound investing can make you
very wealthy if you’re not in too big of a hurry. And it
never makes you poor, which is better.”
“Next to my dad, Ben Graham had more impact
certainly on my business life than any other
individual.”
Portfolio management
“The best way to outperform the market: Don’t
load up on hundreds of stocks;
The Three Wise Men
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“I’m 15% Philip Fisher and 85% Benjamin
Graham”
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Benjamin Graham
Philip Fisher
Charles Munger
Ben Graham (1894 – 1976)
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Dean of financial analysis.
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“before him there was no (financial analysis)
profession and after him they began to call it
that.” --Adam Smith (1972)
Most famous for:
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Security Analysis, coauthored with David
Dodd and published in 1934
The Intelligent Investor, published in 1949
Ben Graham (1894 – 1976)
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Columbia University Bachelor of Science
Messenger in Wall Street brokerage firm
By 1919 (age of 25) was a partner and
earning $600,000/year
In 1926, formed own partnership –
Graham Newman
Dissolved the partnership and retired in
1956
Ben Graham (1894 – 1976)
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While at Graham-Newman taught night
courses in finance at Columbia University
Two most important contributions to
Buffettoloby
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Investment vs. Speculation
A systematic (Quantitative) approach to
investment with the concept of Margin of
Safety.
Investment vs. Speculation
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“An investment operation is one which,
upon thorough analysis, promises safety
of principal and satisfactory return.
Operations not meeting these
requirements are speculative.”
Investment in bonds can also be
speculative. What is important is a
quantitative approach to investment
Three reasons for the Crash of
1929
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Manipulation of stocks by the exchanges
and investment firms
Practice by banks of lending money for the
purpose for buying stocks
Uncontrolled optimism that was driving it
all
The first two have been solved to a large
extent
Three approaches to investment
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Cross-section approach
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Anticipation approach
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Equivalent to today’s indexing or passive
investing
Short-term selectivity – Invest in near term
favorable
Growth stock – Invest in companies with
earnings growth > average
Margin of Safety approach
Margin of Safety Approach
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After deciding what to buy (later), investor
has to decide when to buy
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Buy when everything is selling cheap (bear)
Buy when the particular stock is trading below
its intrinsic value, irrespective of the market
condition
Graham believed the first approach is
futile.
Margin of Safety Approach
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For bonds, margin = Earnings – fixed
charges
Stocks, “When a stock is priced well below
its intrinsic value, a margin of safety
automatically exists.”
Intrinsic value?
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“that value which is determined by facts”
Earning potential
Qualitative factors
Art and science of financial
analysis
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Quant = Balance sheet, Income
Statement, Cash flows,…
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Company assets, earnings and dividends, and
any future DEFINITE prospects
Qualitative – not easy, but essential to
intrinsic value
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Management capability
Nature of business
Margin of Safety
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Graham believed that there is little margin
of safety if the qualitative factors make a
major part of the intrinsic value.
Buy a company for less than two-thirds of
its net asset value (NAV)
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No weight to PPE
Deduct all short/longterm liabilities
focus on stocks with low price-to-earnings
(P/E) ratio
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Wrong market price & mean reversion
Philip Fisher
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Graduated from Standford’s Graduate
School of Business
Analyst at Anglo-London-Paris Bank in San
Francisco
After two years head of Bank’s Statistical
Department
Started advisory firm, Fisher & Company
in 1931
Philip Fisher
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Superior profit in firms with above average
potential with the most capable management.
Point system to identify good companies
“Investment success depends on finding
companies that can sustain above-average
growth, in both sales and profits, over a period
of several years. Short-term results are
deceptive.”
Philip Fisher
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Fortunate and able
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Fortunate because able
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Aluminum Company of America
Dupont
“Investment success depends on finding
companies that can sustain above-average
growth, in both sales and profits, over a period
of several years. Short-term results are
deceptive.”
Essential Qualities
1)
2)
3)
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R&D expense
Strong Marketing
Low break even; lowest-cost producers
Ability to grow without new equity
Superior management
“Superior management is the key to
superior market performance.”
1)
2)
3)
4)
5)
Long term target of consistent
performance?
Management of unquestionable integrity
and honesty?
Do managers communicate with
shareholders?
Relationship between management and
employees?
Management characteristics vs. peers
Scuttlebutt approach
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Find out what kind of reputation the firm has
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Cross-sectional view of the firm
Customers, vendors, former employees,
competitors, trade associations…
Since time consuming, Fisher’s portfolio was
focused on a few stocks. ≈ Buffett’s “Circle of
Competence”
Charles Munger
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“Charlie-and-I”
Functionally investment co-manager
Son of lawyer and grandson of Federal judge
Harvard Law School - Practiced law in LA; Joined
BRK in 1978
“Look for companies that generate high cash
earnings and require low capital expenditure.”
“It is far better to pay a fair price for a great
company than a great price for a fair company.”
See’s Candy 1972
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Turning point in the investment philosophy of
Berkshire Hathaway
Charlie convinced Warren See’s was a good
buy at three times the book value.
Not picking up as many cigar butts!
Put it all together…
it spells success
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Graham = buy cheap, margin of safety, ignore
management and sector (Quant)
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Some of WB’s investments were cheap for a
reason (original Berkshire Hathaway)
View stocks as investments = long-term
Fisher = more business and management
focused (Qual)
Charlie = move WB from 85-15 to 50-50