How to Make a Safe 38% While Wall Street Goes Haywire
By Dan Ferris, editor, Extreme Value
September 20, 2008
Fifteen stocks.
That's all it took to make Warren Buffett the richest man in the world.
A few years back, Forbes columnist Mark Hulbert studied decades of Warren Buffett's investment decisions. Hulbert concluded that just 15 stocks account for Buffett's enormous success. Without them, Hulbert says, Buffett's returns would have been mediocre.
I don't know all 15 names, but we know some of them: Coca-Cola, Gillette, GEICO, Washington Post, Wells Fargo, and American Express are the most famous examples.
Buffett took large positions in these stocks, knowing each was an exceptional company he'd hold indefinitely. (Buffett put half his net worth into GEICO at age 20.)
How does Buffett know when he's looking at a winner good enough to put a big chunk of his net worth into? The answer is simple. Buffett focuses on companies 1) whose businesses he understands, 2) with good management teams, 3) with an enduring competitive advantage, and 4) that are priced to make him rich.
Each of these attributes is a high hurdle. Together, they form a screening tool that eliminates all but the very safest businesses from Buffett's consideration.
Buffett's holding company, Berkshire Hathaway, consists mostly of businesses that sell very simple products: jewelry, furniture, cowboy boots, bricks, carpet, fast food, and the like. It's the same with Berkshire's stock portfolio: soft drinks, used cars, beer, shoes, newspapers, and railroads. These are all businesses you and I can understand... none of the complicated financial instruments currently burning down Wall Street.
But even simple businesses won't do much without a good leader. In his most recent shareholder letter, Buffett tells how he met Dennis Ulrich, owner of a gold jewelry manufacturer. Ulrich convinced Buffett they could build a large jewelry supply business together. Ulrich's ideas impressed Buffett, and Berkshire soon acquired Ulrich's company. By knowing how to spot exceptional businessmen like Dennis Ulrich, Buffett can remain ignorant of the day-to-day details of the jewelry business, and still make plenty of money.
Buffett also insists on buying businesses with an enduring competitive advantage, like Coca-Cola or Gillette. They dominate their industries around the world, and they don't change much over time. They just grow larger.
Moody's is another good example of a business with a big "moat." It's one of a select few Nationally Recognized Statistical Ratings Organizations (NRSROs). The global financial system can't run without NRSROs, which supply report cards on bond issues to investors. Receiving the NRSRO designation from the SEC is clearly an advantage over companies that don't have it. More NRSROs exist today than when Buffett bought Moody's, but not many more... and they don't all compete with Moody's. As long as the SEC keeps its competitors at bay, Moody's will continue to be a fantastic business.
When Buffett finds a company that's easy to understand, has great management, and an enduring competitive advantage, there's still one more, all-important hurdle for the company to get over before he'll invest...
Buffett won't buy unless the price is right (a man after my own heart). He knows what businesses are worth, and he won't buy unless he can get the business at a price below its fair value. He'll only buy at a price he's certain will be profitable for Berkshire Hathaway shareholders. Since he's the biggest shareholder, it's profitable for him, too.
Last November, I recommended my Extreme Value subscribers buy Wal-Mart, because I knew it had all four of Buffett's criteria. It's easy to understand, because it sells everything: furniture, food, clothing, sporting goods... you name it. Management has grown the business to become the No. 1 retailer on Earth. It has a huge competitive advantage in its ability to undersell all its competitors. And at around 11 times pretax earnings, it was way too cheap for such a world-dominating franchise.
Today, through months of terrifying financial volatility, Wal-Mart has steadily climbed up 38%.
When the markets melted down on Monday and Tuesday, in the wake of the Lehman bankruptcy, Merrill Lynch buyout, and AIG crisis... Wal-Mart's stock went up. It's the anti-financial crisis stock.
This is the kind of business that can be one of your "15 stocks." If you have the will to find these stocks... and the patience to buy only at the right price, it'll mean the difference between frustratingly mediocre returns... and a comfortable, secure retirement.
Good investing,
Dan Ferris
Editor's note: Dan Ferris is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
Sign up today to read more investment ideas from Dan Ferris.
|
