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Put the "Value" in Valentine's Day!
By Nancy Zambell, Contributing Editor, Financially Fit
I've just returned from an invigorating trip to the World Money Show in Orlando, Florida. More than 10,000 individual investors met to share ideas and to take part in workshops led by over 150 financial advisors and public companies. Just about every style of investing was represented, including small-caps, growth, technology, options, sector, mutual fund and ETF, technical analysis, fundamental analysis, and my personal favorite - value investing.
I find it interesting to watch the cycles of investing play out, compelling investors to try this new, "can't-miss" strategy, always with the promise of beating the market. Unfortunately, very few actually do beat the market in the long run - except for value investing.
Nothing beats finding a well-run, fundamentally strong company whose shares are trading at less than their intrinsic value, scooping it up, then waiting until the market discovers it, sending its shares to a fair value - at which point you can take your gains.
For more than 20 years, I've made my living doing just that. But don't take my word for it. All you have to do is look at the track record of Warren Buffett, the world's greatest value investor (and often called the world's greatest investor). For more than 40 years, he has handily been beating the returns of the S&P 500. Since 1980, Buffet has outpaced the S&P's gains by more than an average 12% annually.
Buffett learned the tools of the trade as a Columbia University student when he studied under Benjamin Graham, the father of security analysis - and value investing. Graham's thesis: A good investment was a company that was worth considerably more than what its stock was selling for. He determined if a business was "undervalued" by estimating its future earnings and deciphering the current worth of its assets.
And while Wall Street analysts were busy building complicated models to value a company, Graham decided that just a handful of parameters would do: Debt/equity, dividend payouts, P/E ratios, growth prospects, and stable earnings.
Buffett further refined Graham's strategy by meeting with management and intimately getting to know the companies in which he invests, adding intangible criteria to Graham's quantitative factors. Two more important additions - refusing to follow the Wall Street crowd in their prognostications and maintaining a limited number of issues in his portfolio - have helped him continue to turn out double-digit returns year after year.
Buffett began his value investing career back in 1962 when he bought shares in Berkshire Hathaway, a small textile company whose stock he felt was trading at a level not commensurate with the company's long-term value.
Berkshire Hathaway began in 1888 as the Hathaway Manufacturing Company, a cotton miller, founded by China trader Horatio Hathaway. In the 1950s, the business merged with Berkshire Fine Spinning Associates, another milling company that had been in business since the early 19th century. But the combined company - along with the rest of the U.S. textile sector - fell on hard times, closing a number of plants and laying off workers by the end of the decade. The stock price didn't fare so well, either, and in stepped Buffett, who thought the company was severely undervalued.
By 1965, he held a majority stake in the company and while retaining a foothold in the textile industry, began buying stakes in other businesses. He bought into his first insurance companies in 1967, and then used their cash flow to gradually turn Berkshire Hathaway into an investment vehicle, purchasing significant numbers of shares in other companies.
As the U.S. textile industry faded, Buffett had to finally admit defeat in that sector, discontinuing that segment by 1985. But the remaining company thrived.
The types of companies in which Buffet invests have not changed substantially since then; most are consumer-driven companies whose products could be found in the supermarket or the local mall. He's often quoted as saying, "Don't buy any stock you can't explain to your grandmother." And he took a lot of heat during the technology heyday, when he was called a "has-been" for not jumping on the technology bandwagon. But we know who got the last laugh, don't we?
While he does trim his portfolio holdings from time to time, for the most part, Buffett remains a buy-and-hold investor.
As of the end of 2006's third quarter, Berkshire Hathaway held 39 stock positions. His top ten stocks accounted for more than 80% of his portfolio and include American Express (AXP: NYSE), Coca-Cola (KO: NYSE), Conoco Phillips (COP: NYSE), Johnson & Johnson (JNJ: NYSE), Moody's (MO: NYSE), Procter & Gamble (PG: NYSE), Washington Post (WPO: NYSE), Wells Fargo (WFC: NYSE), and Wesco (WSC: AMEX) and Anheuser Busch (BUD: NYSE).
Other major holdings include: Western Union (WU: NYSE), First Data (FDC: NYSE), Iron Mountain (IRM: NYSE), Lowe's (LOW: NYSE), Nike (NKE: NYSE), USG (USG: NYSE), Wal-Mart (WMT: NYSE), Home Depot (HD: NYSE), United Parcel Service (UPS: NYSE), and White Mountains Insurance (WTM: NYSE).
Because Berkshire Hathaway has so much cash in its coffers (currently around $40 billion), Buffett has to primarily buy the shares of large-cap companies; otherwise, the mere event of his purchasing shares would substantially move the price of smaller-cap companies. As it is, when the news emerges of a recent Buffett buy, almost every affected company sees the price of its shares benefit
Not one to pay dividends or to split his stock, Buffett's Berkshire Hathaway stock hit the record-breaking price of $100,000 a share last October - and is still on the rise.
While investors can follow fads all they want, I'll stick with Buffett's winning strategy of more than 40 years - buy undervalued shares in fundamentally strong companies. You could do worse, you know.
Until next week…
This concludes this week's issue of Financially Fit. We encourage you to visit our website to review past issues of Financially Fit:
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