The Buffett Series explores some of the interesting and timeless investment concepts discussed by Mr Buffett in his annual Berkshire letters. Over the years I've found there isn't a lot that Mr. Buffett and his partner Mr. Munger haven't worked out when it comes to investing. I am constantly discovering hidden investment gems, new ways of thinking about businesses and the investment process.
This Series contains ten short essays on concepts that have featured in Mr Buffett's annual letters since the early 1980's. It's amazing how timeless and universal they are. The first essay looks at "What is Value Investing?".
".. we think the very term "value investing" is redundant. What is "investing" if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labeled speculation (which is neither illegal, immoral nor - in our view - financially fattening).
Whether appropriate or not, the term "value investing" is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics - a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield - are in no way inconsistent with a "value" purchase." Warren Buffett - 1992
Over the years Mr Buffett has shifted from buying fair companies at wonderful prices to buying wonderful companies at fair prices. Wonderful companies have the ability to compound earnings over time, unlike optically cheap companies which may provide a one off kicker.
Some examples of such acquisitions by Mr. Buffett include buying See's Candy at 4X book, Scott Fetzer at 1.8X book and more recently Iscar at 5X book.
"In GEICO, we paid 20 times earnings and a fairly sized multiple of book value" Warren Buffett, Berkshire 2013 Meeting.
Ultimately "value" is determined by what you get for what you give. While it is more difficult to ascertain the sustainability of high growth, it doesn't mean a high growth, high PE and high price to book value stock is not a "value" investment. At the same time, lots of stocks that trade on low PE's, low price to book values and high dividend yields have turned out to be terrible investments. They're generally referred to as "value traps". The key is to get back more in future returns than you give up at the time of acquisition. That's what investing is all about.