THE RIGHT PRICE TO PAY:
1.
A GREAT COMPANY AT A FAIR PRICE:
Nobody really knows the specific principles that Warren Buffett applies
when deciding the price he will pay for a share investment. We do know that he
has said on several occasions that it is better to buy a ‘great company at a
fair price than a fair company at a great price’.
This tends to agree with the view of Benjamin Graham who
often referred to primary and secondary stocks. He believed that, although
paying too high a price for any stock was foolish, the risk was higher when the
stock was of secondary grade.
2.
PATIENCE:
The other thing that Warren Buffett counsels, when deciding on
investment purchases, is patience. He has said that he is prepared to wait
forever to buy a stock at the right price.
There is a seeming disparity of views between Graham and Buffett
on diversification. Benjamin Graham was a firm believer, even in relation to
stock purchases at bargain prices, in spreading the risk over a number of share
investments. Warren Buffett, on the other hand, appears to take a different
view: concentrate on just a few stocks.
3. WHAT WARREN BUFFETT SAYS ABOUT DIVERSIFICATION?
In 1992, Buffett said that his investment strategy did not rely upon
spreading his risk over a large number of stocks; he preferred to have his
investments in a limited number of companies.
4.
NO REAL DIFFERENCE BETWEEN BENJAMIN GRAHAM AND
WARREN BUFFETT:
The differences between Graham and Buffett on stock diversification are
perhaps not as wide as they might seem. Graham spoke of diversification
primarily in relation to second grade stocks and it is arguable that the
Buffett approach to stock selection results in the purchase of quality stocks
only.
5.
BERKSHIRE HATHAWAY HOLDINGS:
In addition, consideration of Berkshire Hathaway holdings in 2002
suggests that although Buffett may not necessarily believe in diversification
in the number of companies that it owns, its investments certainly cross a
broad spectrum of industry areas. They include:
- Manufacturing and distribution – underwear, children’s clothing,
farm equipment, shoes, razor blades, soft drinks;
- Retail – furniture, kitchenware
- Insurance
- Financial and accounting products and services
- Flight operations
- Gas pipelines
- Real estate brokerage
- Construction related industries
- Media
6.
INTRINSIC VALUE:
Both Warren Buffett and Benjamin Graham talk about the intrinsic value
of a business, or a share in it. That is, to buy a business, or a share
in it, at a fair price. But, having regard to the possibility of error in
calculating intrinsic value, the careful of investor should provide a margin of
error by only buying the business, or shares, at a substantial discount to the
intrinsic value. Buffett is said to look for a 25 per cent discount, but who
really knows?
7.
DEFINING INTRINSIC VALUE:
Buffett’s concept, in looking at intrinsic value, is that it values what
can be taken out of the business. He has quoted investment guru John Burr
Williams who defined value like this:
‘The value of any stock, bond or business today is determined by the
cash inflows and outflows – discounted at an appropriate interest rate – that
can be expected to occur during the remaining life of the asset.’ – The Theory
of Investment Value.
The difference for Buffett in calculating the value of bonds and shares
is that the investor knows the eventual price of the bond when it matures but
has to guess the price of the share at some future date.
8.
DISCOUNTED CASH FLOW (DCF):
This method of valuation is often referred to as the Discounted Cash
Flow (DCF) valuation method, but, as Buffett has said in relation to shares, it
is not easy to predict future cash flows and this is why he sticks to
investment in companies that are consistent, well managed, and simple to
understand. A company that is hard to understand or those changes frequently
does not allow for easy prediction of future earnings and outgoings.
Ultimately, the investor must decide upon their own methods of arriving
at the intrinsic value of a share and the margin of error that they want for
themselves.
