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Buffett's simple secrets to success

Jason Stipp  |  11 Mar 2015Text size  Decrease  Increase  |  

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Jason Stipp is the site editor for Morningtar US. This article was originally published on the Morningstar US website and therefore any company ratings mentioned are US-specific.


Berkshire Hathaway released its fourth-quarter results and 2014 annual letter over the weekend -- required (and highly anticipated) reading for value investors and Warren Buffett acolytes the world over.

Morningstar's stock analysts will sort through the earnings release in a separate report. Beyond the business results, Buffett's annual letters also include ruminations on investing and more than a handful of insightful quotes to tide investors over until Berkshire's annual meeting -- also known as the "Woodstock for Capitalists" -- which happens the first weekend in May.

Fifty years ago, current management took over at Berkshire, and on the occasion of this year's letter, Buffett and his business partner, Charlie Munger, each recounted the ride, along with their expectations for the next 50 years. Their portions were written independently, the letter stated, and "neither changed a word of his commentary after reading what the other had written".

There was a good bit of overlap between the two accounts and several interesting points worth consideration for investors today -- both Berkshire shareholders and any other fundamentals-based, long-term-minded investors.


Moving beyond cigar butts

Buffett spent time recounting his evolution as an investor and the impact on Berkshire's philosophy. A student of Benjamin Graham, Buffett started his investing career in search of "cigar butts," ailing companies at ultra-cheap prices with one last "puff" in them, but he later realized the strategy wasn't scalable.

"My cigar-butt strategy worked very well while I was managing small sums," Buffett wrote. But it was "scalable only to a point ... Though marginal businesses purchased at cheap prices may be attractive as short-term investments, they are the wrong foundation on which to build a large and enduring enterprise."

Munger, whom Buffett met in 1957, began to lead him away from cigar butts and towards quality companies. Munger's blueprint for Berkshire, Buffett wrote, was: "Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices."

This is a good tonic for today's investing environment, which features very few outright bargains after a years-long market rally. Looking at the opportunity set (which features few 5-star, high-quality stocks), we'd say investors who need exposure to the stock market can do far worse than buying wide-most names -- those with highly durable competitive advantages -- at fair prices (3 stars) when better bargains are hard to come by.


Focus on moats

Such "wonderful businesses" tend to hold up better in downturns and provide meaningful long-term returns for investors to fund retirement or other big personal goals. In the case of Berkshire, they also meant cash flows to reinvest in even more wonderful businesses.

In 1972, Berkshire acquired See's Candy, which, Buffett wrote, "had a huge asset that did not appear on its balance sheet: a broad and durable competitive advantage that gave it significant pricing power. That strength was virtually certain to give See's major gains in earnings over time. Better yet, these would materialize with only minor amounts of incremental investment. In other words, See's could be expected to gush cash for decades to come".

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