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October 25, 2019
Lessons from a 21-year-old Warren Buffett
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October 25, 2019

Lessons from a 21-year-old Warren Buffett


Macro Insight

Lessons from a 21-year-old Warren Buffett

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October 25, 2019

 
 

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

In 1951, a young stockbroker wrote into a local paper to share the investment thesis on his favorite stock. The author described an out-of-favor industry that provided a necessary service to customers who renewed contracts annually.  He identified a company that had established a competitive advantage as the low cost operator by eliminating auto insurance agents. He noted that the business had grown insurance premiums written over 36% annually for over a decade, had the potential to increase pricing, and generated margins more than triple the industry average, even more so in downturns.  The company’s management and board were aligned with shareholders by owning one-third of shares outstanding. Finally, the author noted that the market may underappreciate the long-term value of the business: “it appears that no price is being paid for the tremendous growth potential of the company.1”   

“Price is what you pay, value is what you get.”

At just 21 years old, Warren Buffett demonstrated he already understood that the market price and the intrinsic value of a business are two different variables.  By focusing on the key drivers that underlie the quality of a business, such as GEICO’s2 growth in customers, financial strength and low cost advantage, Buffett reminds us that when you purchase shares of a company, you become a part-owner of a business. And just as you shouldn’t buy a low quality home and risk your family’s safety under a suspect roof on the advice of your real estate agent, it is critical to conduct your own due diligence and know what you own. 

In our International Advantage Strategy, we focus on high quality businesses3.  We assess five elements of a high quality business in our due diligence, including business models with sound fundamentals characterized by competitive advantages and growth that are sustainable with respect to disruptive change, financial strength and ESG externalities (Display 1).  Typically, these are businesses that can increase the prices charged for their goods and services and maintain positive cash flow margins across economic cycles -- in good times and more challenging downturns.

 
 
 
DISPLAY 1: Five attributes of high quality companies
Lessons-from-Buffet-Display-1
 

Attributes shown reflect the views of the investment team, provided for illustrative purposes only, and subject to change.

 
 

“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

A quarter century later in 1976, Buffett revealed that his GEICO shares had accounted for two-thirds of his net worth in 1951: “I told everyone who would listen to me that they should put every cent they could scrape together into GEICO.4”  Like Buffett, we believe that concentrating capital in our highest conviction ideas builds a truly differentiated portfolio. Generating a high conviction idea is the result of long hours of due diligence researching company reports and extensive travel to meet company management.  Identifying the mismatch between the market price and intrinsic value is difficult and infrequent. That is why it is so important to concentrate capital in your highest conviction ideas. Periods of uncertainty and stock market volatility can present opportunities for investors to purchase high quality businesses at substantial discounts to terminal value.  

Terminal value is determined by the quality of the underlying business.  The fundamentals Buffett highlighted in 1951 - competitive advantage, growth in pricing and units and sustainable margins – ultimately determine terminal value.  The hallmark of our investment team is understanding how companies can monetize their uniqueness over time.  

By owning a concentrated portfolio of high quality businesses purchased at a margin of safety, we believe we can capture opportunities and persevere through market downturns.

 
kristian.heugh
 
Managing Director
 
marc.fox
 
Executive Director
 
 
 
 

Buffett, Warren E. “The Security I Like Best.” The Commercial and Financial Chronicle. December 6, 1951. Page 24 of the 2005 Berkshire Hathaway Annual Shareholder Letter available at: http://www.berkshirehathaway.com/2005ar/2005ar.pdf 

2 GEICO has not been publicly traded since 1996 when it was acquired by Berkshire Hathaway. The International Advantage Strategy does not hold any of the securities mentioned in this publication.

3 The team applies what they believe to be investment principles similar to those of Warren Buffett. No representation is being made that the team's investment results will be similar to those produced by investment portfolios managed by Warren Buffett.

Buffett, Warren E. Letter to George D. Young. July 22, 1976

Past performance is no guarantee of future results. Not all holdings held in the portfolio has or will contribute positively to performance during up or down markets. All investments involve risks including the possible loss or principal.

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