The New Buffettology: How Warren Buffett Got and Stayed Rich in Markets Like This and How You Can Too! by Mary Buffett, David Clark, David Clark

From the Publisher

If you read the original Buffettology, you know exactly half of what you need to know to effectively apply Warren Buffett's investment strategies.

Published in 1997, the bestselling Buffettology was written specifically for investors in the midst of a long bull market. Since then we've seen the internet bubble burst, the collapse of Enron, and investors scrambling to move their assets — what remains of them — back to the safety of traditional blue chip companies. As price peaks turned into troughs, worried investors wondered if there was any constant in today's volatile market. The answer is yes: Warren Buffett's value investing strategies make money.

The New Buffettology is the first guide to Warren Buffett's selective contrarian investment strategy for exploiting down stocks — a strategy that has made him the nation's second-richest person. Designed to teach investors how to decipher and use financial information the way Buffett himself does, this book guides investors through opportunity-rich bear markets, walking them step-by-step through the equations and formulas Buffett uses to determine what to buy, what to sell — and when. Authors Mary Buffett and David Clark explore Buffett's recent investments in detail, proving time and again that his strategy has earned enormous profits at a time no one expects them to — and with almost zero risk to his capital.

In short, The New Buffettology is an essential companion to the original Buffettology, a road map to investment success in the worst of times.

Product Details

• Table of Contents
• Forewords & Introductions
• Read an Excerpt
• Read a Sample Chapter

Table of Contents

Forewords & Introductions

Introduction: The Human Desire Project

The nature of man as a combination of mind and body is such that it is bound to mislead him from time to time.

-- René Descartes

Most of us have no idea what we really want.

We know we want something -- and we want it with great longing and passion, even ferocity. We just cannot seem to get a handle on what it is. This inability feels particularly peculiar now, when our species is so obsessively attentive to issues of satisfaction, self and otherwise, and when the line-up of things to acquire, to do, to experience, to achieve -- to desire -- is more vast and compelling than ever before. Our culture prompts us to consider our appetites every waking hour of the day: want this, want this, want this. Yet there is always at the back of our minds the twinge of some enigmatic hankering -- a feeling that what would really do it for us has yet to be identified or even created.

We seem to understand even less about the true wants and needs -- the defining desires -- of everybody else. "What is it?" we constantly wonder of one another. "Enlighten me. Work with me. Just tell me what you want." For most of us, the answer remains a kind of rumbling mystery, whether we are thinking about what to have for dinner or what to do with the rest of our lives.

Why?

Because the dynamics of human desire have rather recently been transformed. It is a change that has been sneaking up on us, catching us mostly unaware and unprepared. As we were looking about for the big news of the future in the world around us -- investigating socioeconomic trends and demographic shifts, political revisions and planetary modifications, gazing into the stunning headlights of technology, or struggling to see daylight through the smoke of an exploding architecture of global power -- the real revolution has been going on invisibly and nearly imperceptibly inside us, in what it is that makes us (and not our mere machines and social structures) tick now. The big transformation of this transformational era is a recasting of the essential nature of the human being, beginning with that most elemental of realities, the human survival instinct -- the source from which all appetites, fears, and enthusiasms flow. This profound change in the dynamics of human desire may well mark the division between Human History Part I and Human History Part II.

Human behavior is now being ruled by a new pleasure imperative -- a new primal desire -- that is at least as powerful as the one that brought each of us into the world. Although, as you will see, the goal is consummately peaceful, the experience of the new primal desire is provocative, indeed. It needles, it goads, it exhorts, for no desire of the primal variety is ever a wilting lily. It keeps us from our slumbers and visits us in our dreams. It pokes at us as we hide behind a gaze in those brief, empty-headed moments on the bus, behind the wheel, standing in line, facing the mirror -- or pushing a cart or a mouse through endless lineups of things for sale. Evidence suggests it has overtaken not only sex, but also money and power as the most persuasive -- and irresistible -- driver of our twenty-first-century behavior. Ultimately, this new dynamic of motivation, persuasion, and behavior will compel the creation of an entirely new architecture of human exchange -- a new model of the marketplace and human relationship -- which will reshape human society with a transformative power that rivals that of technology itself.

This is a fairly significant event.

To say the least, this change in human desire presents a professional challenge for those people whose livelihoods depend upon understanding what is going on inside other people's hearts and minds -- the pitchmen, the persuaders, and the wooers of the world -- whether they are in the business of selling or politics or religion or writing love songs. But even before we get to the work of pitching and wooing, of rallying and missioneering, there is the ever-present, personal issue of our own hearts and minds. Wouldn't it be great if we could finally figure out what is going on in there? Great for our lives, great for our selves -- and yes, great for business -- because we would be armed with a powerful, deep-insider intelligence. The most critical requirement for success in the future is recognizing, understanding, and addressing the big change in what we want.

This need-to-know is, in fact, the mission that launched The Human Desire Project, an ongoing investigation that began in 1996, and whose discoveries this book reports. The Human Desire Project led to a new vision of the future -- and a new model for successful transaction -- that is at least as critical for the individual -- for each of us, you and me -- as it is for the corporate clients who were the project's original stakeholders. This book is designed to share both the learning and the adventure: the discoveries, insights, musings, and imaginings of participating thinkers, the juicy insider stories, facts and figures, and the conclusions that took even the participants by surprise.

The Human Desire Project is an initiative of my company, The Next Group, a think tank founded in 1993 to provide a new kind of resource for people making high-stakes gambles on the future. We observe, investigate, and analyze human behavior -- both theoretically and in the trenches of the real world -- and use those insights to inform our clients of opportunities for innovation in the marketplace and the culture. We have been described as hired-gun visionaries, a description I rather like, because our work, though intellectually driven and unabashedly visionary, is emphatically pragmatic. Our blue-sky thinking is firmly grounded in the service of no-nonsense corporate task masters -- companies such as AT&T, Merck Pharmaceuticals, Diageo, Unilever, Lucent Technologies, Campbell Soup Company, L'Oréal, Miller Brewing, Corning, Viacom, and Procter & Gamble, to name a few -- as well as new start-ups backed by investors such as Intel, Rupert Murdoch's News Corporation, and Warburg Pincus. We have also worked with political candidates, venture capitalists, icons of popular culture, and even a well-known religious figure. (Who among us is not in the business of selling something to someone else?)

And so the starting point for our investigations is the flashpoint of desire in the culture: the marketplace. It is there that we make not only our most frequent and straightforward expressions of desire, but also our most documentable ones. Evidence of desire old and new is most easily seen in the great open space of the agora, where the exchange of something for something is plainly revealed. However, like the human heart and mind, the culture of the marketplace -- the very idea of life-as-one-big-sales-negotiation: "I want this, you want that, let me try and sell you this exchange" -- encompasses a lot of territory, embracing just about every human endeavor. Marketing practices have infiltrated our lives, from the most public to the most private of concerns. Even foreign policy and the patterns of our sex lives are manipulated by the furies of market research, advertising, and spin.1 We may not like the idea that even our most intimate lives are governed by the laws of the marketplace -- but they are. The politics of persuasion, seduction, negotiation, and exchange -- of skillfully shaping the quid pro quo -- the something for something -- that makes the sale, cinches the deal, and in some circles, seals it with a kiss -- is the law of our current jungle. We are all in the persuasion business -- selling an idea, an opinion, a vision of how a relationship (or the next ten minutes) should go forward, an understanding of "the truth," our very selves. (Consider the amount of attention given lately to the concept of "personal branding" -- the way we present ourselves to potential employers, colleagues, and other players in the great game of life.) Some may use the skills of persuasion in a more commercial context than others, some with more self-awareness, skill, or aplomb. But none of us escapes the necessity of negotiating human exchange, or the power of desire politics to shape our lives. The moment any one of us invests in an agenda that is not hermetically solitary, persuasion becomes the critical task.

So when I speak of the business of desire in this book, I am talking to every one of us: those who are marketers by profession, but also those who qualify as marketers simply by dint of being alive. The politics of desire is a basic dynamic of life. It includes any pursuit that lives by the mysterious laws of has/gets: the marketplace itself, management and diplomacy, politics and policy, relationships and romance, religion and war, power and fame. In all of the heart-and-mind fields of life, those people with the keenest understanding of how to address human desire ultimately prevail.

Given how triumphant the model of the marketplace has been in taking over so many aspects of our civilization, one might expect established marketing science and its insights to be right on the money when it comes to understanding how the human heart and mind work now. In fact, someone, somewhere, right this minute, is speechifying about how some imagined secret collaborative of cereal makers, car companies, and soft drink manufacturers has created the ultimate sneaky algorithm to tap into our cravings and control us all. Such is not the case, as every marketing pro reading these sentences is secretly, sadly, and with reluctant denial of omnipotence, acknowledging.

If it were true, marketing science would not see such astonishing rates of failure: up to 95 percent of all new products, for instance, are destined to end in a bloodbath of red ink and oblivion. So while it is difficult to imagine a culture more deeply invested in innovation than consumer marketing ("It's new! It's improved! It's the next big thing!"), the official marketing world is revealing itself to be one of the most ironbound, anti-insightful, anti-visionary industries still alive these days -- even as it engages in the business of innovation itself. The official mouthpiece of new news in the world of desire has become a dusty old compendium of clichés and conventional wisdoms, many established way back in the fifties and sixties. In turbulent times, even the champions of change tend to cling to what they perceive to be the status quo. Mature markets, unpredictable economic karma, scary times, and the powerful reflex to hold on tight to the familiar when everything else seems to be madly morphing, make most marketers afraid not to follow the established canon of insights into what makes us want the things we want and do the things we do. And so we have a marketing industry whose efforts are inspired not by real and true insight into people's hearts and minds, but by excessive attachment to outdated research techniques, technology, internal political agendas, the service of method over mission, or paranoid projections of what the competition might do -- a competition that is probably equally trapped in a consumer-intelligence time-warp -- the marketing-insight equivalent of your father's Oldsmobile, windows up, doors locked. Classic premise and methodology are plainly discernible and politically difficult to fault, even as they continue to fail.

It is true that the community of commerce has exerted enormous effort at understanding the new mechanics of the business of desire: the rush of new technology that changes the whole playing field of communication, distribution, and selling; global brand management, database mining, digital culture, and that still-ruling king of corporate self-satisfaction, "core -- this is what we do -- competency." But the prevailing assumptions of how the consumer mind works have been unexamined -- and obsolescent -- for years. How ironic it is that the business of desire has become so obsessed with every revolution that affects the structure of commerce -- bricks or clicks? global or local? content or conduit? lone crusade or mega-alliance? -- that it has been largely oblivious to the revolution in desire itself that may well make all of these issues beside the point. The process of rearranging deck chairs on the Titanic comes to mind.

This failure of insight on the part of the marketing industry -- the mothers of desire, as it were -- creates a bizarre disconnect in all of our lives. The loudest voices of human want and need in the culture are strangely out of sync with the quieter -- but more compelling -- voices inside our own heads. We struggle with the sensation that there are two realities going down -- our own private inner hungers and the loud public hungers that rule the airwaves and the conventional wisdom.

Our truest, most powerful desires are undercover, in the dark, misunderstood, and disquietingly -- weirdly -- unrecognized by the prevailing premises of official marketing science. The purpose of The Human Desire Project, and this book, is to go boldly in there, into the dark, where the true motivating power of our lives dwells, to have a good look around, ask the important questions, and come out with a plan. Why do we want the things we want and do the things we do? And how do we use these new insights to find greater satisfaction and success in our personal and professional lives?

The Project began with a straightforward research and development proposition: to identify those products, services, ideas, enthusiasms, and innovations that will strike a successful chord in the future. What will be the big motivators of our twenty-first-century spending behavior? What will make our eyes grow wide, our pulses quicken, and our wallets open? In short, what will people buy? This question led, inevitably, to the bigger question before us right now: what do human beings really want? We discovered that this is, in fact, the question of the century -- the futurist's equivalent of the physicist's "answer for everything," the explanation of the origins of the universe. For human desire is the ultimate force of creation. What we want determines who we are and what we will make of this world. Given the nature of the question, I suppose we at The Next Group should not have been surprised that what started out as a mission for big business became, in addition, an amazingly personal adventure for everyone involved, a journey into an interior landscape that is both intimately familiar and totally unexpected: the mysteries of the human heart and mind in the throes of an astonishing metamorphosis.

Like all Next Group investigations, The Human Desire Project goes forward as a collaborative of insider experts. These beloved "peripheral visionaries" (a term I lift, with a bow, from Tom Peters) represent an extraordinary assemblage of cutting-edge expertise, indeed -- celebrated thinkers, authorities, movers and shakers from virtually every field of inquiry and enthusiasm alive and kicking in the human circus. Our process is inspired by a vigorous belief in the powers of interdisciplinary collaboration. There is priceless enlightenment to be found in identifying those hot zones where apparently divergent phenomena -- say, technology, religion, fashion, intellectual inquiry, supermarket trends, science, popular entertainment, visual and literary art, the cult of celebrity, and the ruminations of scholarly genius -- converge.

Our expert ranks include research scientists and scholars, poets and choreographers, corporate chairmen and cultural alphas, psychiatrists and senior marketing executives, artists and authors, policy wonks and theme park designers, film producers and neurophysiologists, media whizzes and quantum physicists, performance artists and digital-world-makers, epidemiologists and educators, healers (AMA, shamanic, and otherwise) and trendsetting chefs, Chasidic rabbis and rock promoters, social anthropologists and retailing gurus, molecular biologists and architects, professors and award-winning screenwriters, magazine editors and journalists -- the insider knowers and analyzers of the news along with the newsmakers themselves. Our objective is to capture an advance look at what's next from that most insider of all possible views -- the inside of the heads of the imagineers of the future. We look for telling cross-category convergences -- common grounds of cutting-edge curiosity, theory, point of view, passion -- that point a knowing finger in the direction of the Next Big Aha. From our cross-category perch, we are able to spot surprising and powerful new commonalities shared by even the most dissimilar fields, and to identify new forces that will drive innovation in both the culture and the marketplace. Our ongoing intelligence work allows us to discover the fires of the future while they are still just a twinkle in an insider's eye. It is an extremely privileged perspective on coming attractions.

We work together in many ways: in think-tank sessions, one-on-one interviews, collaborative e-mail threads, and, when possible, on the expert's own turf (hence the references you will see throughout this book to such diverse locations as molecular biology labs, drumming circles, Margaret Mead's old office at the AmericanMuseum of Natural History, chefs' kitchens, centers for nuclear medicine and brain imaging, artists' studios, Swiss clinics, black market phone shops in Singapore, absinthe bars in London, the many new descendants of the old Bell Labs, the dressing rooms of underground drag clubs, and the hallowed halls of Harvard and Yale). Our work is a labor of curiosity -- a kind of thinking man's and woman's romp through the passions of the future. In fact, romp and passion is a critical part of the process. Our think-tank methodology emphasizes the importance of not only the rational data and insights our experts provide, but also the irrational data, the personal revelation -- the heart of their desire. For it is what is inside the hearts as well as the minds of cultural alphas that determines the direction the culture will take. For reasons that will become clear to you as you progress through this book, our think-tanks frequently become a kind of group therapy session in which the deepest drivers behind an expert's work are revealed. What begins as a rousing camaraderie of intellectual competition, cosmic flashes, and stream-of-consciousness connection-making often becomes an experience of unexpected and astonishingly personal, communal discovery. One cosmic convergence in particular has been revealed.

Over the last few years, we have witnessed an extraordinary phenomenon in our think-tank sessions at The Next Group. No matter what fields the assembled experts and alphas represent -- be it physics, finance, food, or sports. No matter what the subject on the table -- be it health care, luxury, digital lifestyle, or sex. And no matter how aggressively concrete the ultimate application might be -- whether it be new businesses to develop, new policies to implement, new candidates to support, new products to create. Virtually every strategic excursion into the future has become an investigation, ultimately and inevitably, into what I call the imaginational -- the invisible, the uncanny, the intangible, the interior, the ungraspable -- what is known in some circles as non-ordinary or consciousness-based reality, the triumph of the unseen, The Castaneda Effect, ironic science, or, occasionally, by remaining skeptics, as "the woo woo."

We seem to be spending a lot more time these days in what we once perceived to be an alternative reality.

This is a staggering turn of events, certainly in my twenty-some years in the business of investigating the culture. And it is not something that I went looking for, or even bought into for a long, long time, for I am a stubborn pragmatist who came to all of this etheriosity with more than a little chip of skepticism on my shoulder. But there you have it.

We start off talking about medicine with hard-nosed scientists and physicians, and end up talking about belief systems and destinations of the mind. We start off talking about design with real estate developers and engineers, and end up talking about positive energy flow and mood manipulation. We start off talking about golf with no-nonsense executives, and end up talking about oneness with the universe. We start off talking about the stock market with financial and economic specialists, and end up talking about primitive terror of the invisible. We start off talking about crime or foreign enemies with those authorities who are actively engaged in our defense, and end up talking about clairvoyance, belief systems, and unseen sources of paranoia. We start off talking about communication networks with fiber optics engineers, and end up talking about the experience of the divine. We start off talking about travel and leisure with credit card company executives, and end up talking about out-of-body experiences, mind trips, and interior flights of fancy. We start off talking about fashion with international retailing conglomerates, and end up talking about inner self, hidden identities, multiple personalities, reincarnation, detailed plans for reincarnation. In fact, so urgently do our experts zero in on this inside stuff, it is as if all of the astonishing transformations going on in the world around us -- techno-triumph after techno-triumph, colossal demographic shifts, staggering revisions of the planet, world-morphing socioeconomic trends -- are all merely old-think background to some much more astonishing and supremely more significant transformation going on, well, in our own minds: the exploration and colonization of an entirely new frontier that is not of this world. The most portentous phenomenon I have experienced in all of my years of looking for what's next is this: an unprecedented number of people -- both the people who create the newnesses of the future (like these experts) and the people who accept them or reject them (like you and me) -- have switched worlds. It is in this new world that the truth of human desire -- and the future of us all -- resides.

This book is an invitation to join in a strategic expedition into the heart of it, in pursuit of reward that is both intimate and worldly, personal and professional -- fully equipped with the same insights and strategies that inform the future plans of some of the most powerful corporate movers and shakers around. The Human Desire Project presents an unconventional vision of the future, derived using unconventional means, and resulting in an unconventional plan of action -- for our goal is to succeed in unconventional times. In keeping with this premise, I have presented this vision in somewhat unconventional terms. You will see throughout the book that the text is frequently interrupted with "hypertext," intended as a kind of deeper, experiential illumination of the main ideas. Our concept of the future is, above all, personal. These hypertexts invite you to engage the ideas in a deeply personal way -- with quizzes that guide you in finding yourself in this new model of the universe, with the words and stories of others who have experienced it, and with excursions into the inner workings of The Human Desire Project itself.

You will notice also that, unlike many books that originate in the world of business, this book spends most of its time in the world of human beings. Imagine that. It is my stalwart conviction -- and that of my smartest clients -- that business innovation must follow the lead of the consumer (which is just another word, after all, for human being). It is hubris to think that the marketplace still works the other way around. And so this book begins with the human side of our mysterious new reality. Join me in a close-up look at the five new personal strategies that we as individuals are instinctively -- and mostly unconsciously -- employing in order to make sense of a baffling new world and ultimately find satisfaction. These are the forces that drive human behavior now. Developing insights into these forces -- and using those insights for success, in our business and in our lives -- is the purpose of The Human Desire Project and this book.

So, think of your reading as a professional investment -- to gain an insider's look into the new ruling dynamic of motivation, persuasion, and behavior that will transform all business playing fields. Or think of it as a personal adventure, a kind of guided safari inside your own head, complete with treasure maps, campfire stories, and survival instructions. Ultimately, the destination is the same: a vision of the future that may feel to you both outrageous and inevitable, as it did to those of us who participated in the Project -- and an answer to that crucial futurist's question: what do we do now?

Copyright © 2002 by Melinda Davis

Read an Excerpt

7

Using Warren's Investment Methods to Avoid the Next High-Tech Massacre

Now that you have Warren's concept of durability in your head, let's diverge from our path for a moment and discuss why Warren doesn't invest in transforming industries like the Internet.

Warren believes that many investors get caught up in the visions of grandeur that accompany new industries that promise to reshape and transform society. Other transforming industries have caught investors' imaginations — the radio, automobile, airline, and biotech industries. All sparked investors' dreams of immediate wealth, which in turn caused a massive run-up in share prices as the investing public went wild pumping money into them. This of course created higher share prices, which vindicated the investors' decisions and serves as an enticement to invest even more. Many people see others getting rich and they too join the game, which sends stock prices soaring even higher. This process often continues until economic reality is left far behind. But it can't go on forever, for economic reality is like gravity. At some point the bubble bursts and stock prices fall.

From 1919 to 1939 alone, more than three hundred airline manufacturers came and went. Fewer than ten survive today. And what about their brethren the airlines? In the past twenty years, 129 carriers have filed for bankruptcy. In fact, until 1992, the total amount lost by airlines that went bankrupt was far greater than the total they made. The Internet carnage is equally sobering — hundreds of these companies, some that once commanded $100 or more a share, have become nothing but bitter memories in the minds of theirshareholders.

For Warren, the problem with transforming industries is that they seldom, if ever, establish any kind of durable competitive advantage due to the intense competition that exists in the infancy of any industry. Intense competition equates of course to lower profits, which ultimately kills a soaring stock price. Also, in new industry sectors, businesses evolve through countless permutations before establishing any kind of durable competitive advantage. That new businesses by definition have no history of product durability — one of the cornerstones of Warren's selective contrarian investment philosophy — is another strike against them.

Lack of durability keeps Warren from investing in these emerging industries on principle, but he nevertheless likes to hypothetically consider purchasing such businesses whole. He believes that if the entire company isn't worth purchasing at the current stock market price, he shouldn't even buy one share. It is a unique way to look at a prospective investment and one that is shunned by most of Wall Street.

To understand Warren's whole business approach you need to know how to calculate what is called the company's stock market capitalization or, as it is commonly known, the company's market cap.

The market cap is computed by multiplying the number of shares outstanding by the current market price of one share of the company's stock. Let's say that Company X has 100 million shares outstanding and is trading at $50 a share. The market cap for Company X would be $5 billion (100 million shares x $50 a share = $5 billion). If the price of Company X's stock dropped the next day to, say, $45 a share, its market cap would drop to $4.5 billion (100 million shares x $45 a share = $4.5 billion). Conversely the market cap would increase if Company X's stock price went up.

When Warren considers whether to make an investment in Company X, he asks himself the following questions: If the company in question had a market cap of $5 billion and I had $5 billion sitting in my bank account, would I use it to buy the whole company? What kind of return would I get if I paid $5 billion for the company? If he finds the rate of return attractive, he will invest in the company. Notice that he is not asking whether the stock price of the company will go up. Rather, he asks how much will he likely earn given the price that he pays for the entire business.

Let's run through an example. Suppose you were thinking about investing in Yahoo! back on March 10, 2000. Its trading price at that time was $178 a share, and it had a market cap of approximately $97 billion. The question would have been this: If you had $97 billion, would you have been willing to spend it to buy the entire company?

Before you spent you $97 billion, you might just have looked over your other investment options before forking over all that cash for a big ride on Yahoo!. The first thing you discover is that you can invest your $97 billion in U.S. treasury bonds and get a 7% return, which means that you would be earning approximately $6.7 billion a year in interest. Not bad. Compare this to the $70.8 million that Yahoo! was expected to earn in 2000 and the treasury bonds look far more enticing and enriching.

But say that you are a true believer in the Internet and think Yahoo! has a great future! Warren would argue that this may be true, but if you buy all of Yahoo!, you are going to be giving up $6.7 billion in yearly interest income in exchange for the $70.8 million a year that Yahoo! is earning. You, in turn, argue that Yahoo! will earn great sums in the future. Warren would argue that this may also be true. But for each future year you give up the $6.7 billion in interest income, that's $6.7 billion more that Yahoo! is going to have to earn just to keep you even. After even a few years, a billion here and a billion there start to add up. (To keep this in perspective, in 2000, Coca-Cola earned approximately $2.1 billion and General Motors earned approximately $4.4 billion. It takes a hell of a business to generate $6.7 billion in earnings.) It doesn't take a genius to see that buying all of Yahoo! might not be the smartest thing to do with your $97 billion. InWarren's mind it's a short step from there to the conclusion that buying a single share is also a bad idea.

Compare our prospective investment in Yahoo! with an investment in insurance giant and Buffett favorite Allstate. On March 10, 2000, during an insurance recession, Warren was rumored to have been buying Allstate at approximately $18 a share. (As of this writing, this rumor has not been confirmed. We shall assume it is true for the purposes of the hypothetical.) Allstate in 2000 had 749 million shares outstanding, which gave it a market cap of $13.4 billion (749 million shares x $18 a share = $13.4 billion.) It earned approximately $2.2 billion a year. This means that if you spent $13.4 billion buying all of Allstate in 2000, so that you owned the entire company, you would have earned $2.2 billion in income, which equates to approximately 16.4% a year on your money. This is a much better deal than you would have gotten by paying $97 billion for Yahoo! to earn only $220 million, which equates to earning less than 1% a year on your money. In fact, an investment in Allstate is a much better investment than Uncle Sam's treasury bonds.

In truth it is doubtful that anyone other than Warren and a few financial titans are going to cough up $97 billion for a company. We small frys are stuck buying fractional interests in these companies. But remember, Warren believes that if it isn't worth buying the whole company, you shouldn't even buy one share. He also believes that if it is worth buying the entire company, one should buy as many shares as possible.

So suppose we invested $50,000 in Yahoo! on March 10, 2000. Let's also assume that on March 10, 2000, Warren invested $50,000 in Allstate when it was trading at $18 a share. By April of 2001, Yahoo! had dropped from $178 a share to $15 a share, giving us a loss of approximately 91%, reducing our $50,000 investment in Yahoo! to $4,215. The stock price dropped because investors got tired waiting for the $6.7 billion in earnings to arrive. Remember, grim economic reality can drag a stock price to the ground. If the earnings don't show up, investors don't either.

On the other hand, Warren's Allstate investment grew from $18 a share to $40, giving him a 122% return, increasing his $50,000 investment to approximately $111,111. Warren was in good hands with Allstate because he wasn't buying pie in the sky, but real earnings at a price that made business sense. (It is interesting to note that one of the reasons why Allstate was selling so cheap was that everyone else was out chasing the fast bucks being made in Internet stocks. Investors' money fled the old economy for the new economy. They didn't want to own a stodgy old insurance company. The price of its shares went down and created Warren's rumored buying opportunity.)

What keeps Warren from investing in transforming industries is a lack of a durable competitive advantage, plus astronomical selling prices that don't make business sense given the economic reality of the business. If doesn't make sense to buy the entire business, it doesn't make sense to buy a single share no matter how sweet the pie looks.

WHAT YOU SHOULD HAVE LEARNED FROM THIS CHAPTER

* Lack of a historical durable competitive advantage keeps Warren from investing in emerging industries.

* When Warren considers whether to make an investment in Company X, he asks himself the following question: If the company in question had a market cap of $5 billion and I had $5 billion sitting in my bank account, would it be a wise use of my money to buy the whole company?

* Warren likes to play a little game and pretend that he is going to buy the whole business. He believes that if the entire company isn't worth purchasing at the current stock market price, he shouldn't buy even one share.

Copyright © 2002 by Mary Buffett and David Clark

Read a Sample Chapter

7

Using Warren's Investment Methods to Avoid the Next High-Tech Massacre

Now that you have Warren's concept of durability in your head, let's diverge from our path for a moment and discuss why Warren doesn't invest in transforming industries like the Internet.

Warren believes that many investors get caught up in the visions of grandeur that accompany new industries that promise to reshape and transform society. Other transforming industries have caught investors' imaginations -- the radio, automobile, airline, and biotech industries. All sparked investors' dreams of immediate wealth, which in turn caused a massive run-up in share prices as the investing public went wild pumping money into them. This of course created higher share prices, which vindicated the investors' decisions and serves as an enticement to invest even more. Many people see others getting rich and they too join the game, which sends stock prices soaring even higher. This process often continues until economic reality is left far behind. But it can't go on forever, for economic reality is like gravity. At some point the bubble bursts and stock prices fall.

From 1919 to 1939 alone, more than three hundred airline manufacturers came and went. Fewer than ten survive today. And what about their brethren the airlines? In the past twenty years, 129 carriers have filed for bankruptcy. In fact, until 1992, the total amount lost by airlines that went bankrupt was far greater than the total they made. The Internet carnage is equally sobering -- hundreds of these companies, some that once commanded $100 or more a share, have become nothing but bitter memories in the minds of their shareholders.

For Warren, the problem with transforming industries is that they seldom, if ever, establish any kind of durable competitive advantage due to the intense competition that exists in the infancy of any industry. Intense competition equates of course to lower profits, which ultimately kills a soaring stock price. Also, in new industry sectors, businesses evolve through countless permutations before establishing any kind of durable competitive advantage. That new businesses by definition have no history of product durability -- one of the cornerstones of Warren's selective contrarian investment philosophy -- is another strike against them.

Lack of durability keeps Warren from investing in these emerging industries on principle, but he nevertheless likes to hypothetically consider purchasing such businesses whole. He believes that if the entire company isn't worth purchasing at the current stock market price, he shouldn't even buy one share. It is a unique way to look at a prospective investment and one that is shunned by most of Wall Street.

To understand Warren's whole business approach you need to know how to calculate what is called the company's stock market capitalization or, as it is commonly known, the company's market cap.

The market cap is computed by multiplying the number of shares outstanding by the current market price of one share of the company's stock. Let's say that Company X has 100 million shares outstanding and is trading at $50 a share. The market cap for Company X would be $5 billion (100 million shares x $50 a share = $5 billion). If the price of Company X's stock dropped the next day to, say, $45 a share, its market cap would drop to $4.5 billion (100 million shares x $45 a share = $4.5 billion). Conversely the market cap would increase if Company X's stock price went up.

When Warren considers whether to make an investment in Company X, he asks himself the following questions: If the company in question had a market cap of $5 billion and I had $5 billion sitting in my bank account, would I use it to buy the whole company? What kind of return would I get if I paid $5 billion for the company? If he finds the rate of return attractive, he will invest in the company. Notice that he is not asking whether the stock price of the company will go up. Rather, he asks how much will he likely earn given the price that he pays for the entire business.

Let's run through an example. Suppose you were thinking about investing in Yahoo! back on March 10, 2000. Its trading price at that time was $178 a share, and it had a market cap of approximately $97 billion. The question would have been this: If you had $97 billion, would you have been willing to spend it to buy the entire company?

Before you spent you $97 billion, you might just have looked over your other investment options before forking over all that cash for a big ride on Yahoo!. The first thing you discover is that you can invest your $97 billion in U.S. treasury bonds and get a 7% return, which means that you would be earning approximately $6.7 billion a year in interest. Not bad. Compare this to the $70.8 million that Yahoo! was expected to earn in 2000 and the treasury bonds look far more enticing and enriching.

But say that you are a true believer in the Internet and think Yahoo! has a great future! Warren would argue that this may be true, but if you buy all of Yahoo!, you are going to be giving up $6.7 billion in yearly interest income in exchange for the $70.8 million a year that Yahoo! is earning. You, in turn, argue that Yahoo! will earn great sums in the future. Warren would argue that this may also be true. But for each future year you give up the $6.7 billion in interest income, that's $6.7 billion more that Yahoo! is going to have to earn just to keep you even. After even a few years, a billion here and a billion there start to add up. (To keep this in perspective, in 2000, Coca-Cola earned approximately $2.1 billion and General Motors earned approximately $4.4 billion. It takes a hell of a business to generate $6.7 billion in earnings.) It doesn't take a genius to see that buying all of Yahoo! might not be the smartest thing to do with your $97 billion. InWarren's mind it's a short step from there to the conclusion that buying a single share is also a bad idea.

Compare our prospective investment in Yahoo! with an investment in insurance giant and Buffett favorite Allstate. On March 10, 2000, during an insurance recession, Warren was rumored to have been buying Allstate at approximately $18 a share. (As of this writing, this rumor has not been confirmed. We shall assume it is true for the purposes of the hypothetical.) Allstate in 2000 had 749 million shares outstanding, which gave it a market cap of $13.4 billion (749 million shares x $18 a share = $13.4 billion.) It earned approximately $2.2 billion a year. This means that if you spent $13.4 billion buying all of Allstate in 2000, so that you owned the entire company, you would have earned $2.2 billion in income, which equates to approximately 16.4% a year on your money. This is a much better deal than you would have gotten by paying $97 billion for Yahoo! to earn only $220 million, which equates to earning less than 1% a year on your money. In fact, an investment in Allstate is a much better investment than Uncle Sam's treasury bonds.

In truth it is doubtful that anyone other than Warren and a few financial titans are going to cough up $97 billion for a company. We small frys are stuck buying fractional interests in these companies. But remember, Warren believes that if it isn't worth buying the whole company, you shouldn't even buy one share. He also believes that if it is worth buying the entire company, one should buy as many shares as possible.

So suppose we invested $50,000 in Yahoo! on March 10, 2000. Let's also assume that on March 10, 2000, Warren invested $50,000 in Allstate when it was trading at $18 a share. By April of 2001, Yahoo! had dropped from $178 a share to $15 a share, giving us a loss of approximately 91%, reducing our $50,000 investment in Yahoo! to $4,215. The stock price dropped because investors got tired waiting for the $6.7 billion in earnings to arrive. Remember, grim economic reality can drag a stock price to the ground. If the earnings don't show up, investors don't either.

On the other hand, Warren's Allstate investment grew from $18 a share to $40, giving him a 122% return, increasing his $50,000 investment to approximately $111,111. Warren was in good hands with Allstate because he wasn't buying pie in the sky, but real earnings at a price that made business sense. (It is interesting to note that one of the reasons why Allstate was selling so cheap was that everyone else was out chasing the fast bucks being made in Internet stocks. Investors' money fled the old economy for the new economy. They didn't want to own a stodgy old insurance company. The price of its shares went down and created Warren's rumored buying opportunity.)

What keeps Warren from investing in transforming industries is a lack of a durable competitive advantage, plus astronomical selling prices that don't make business sense given the economic reality of the business. If doesn't make sense to buy the entire business, it doesn't make sense to buy a single share no matter how sweet the pie looks.

WHAT YOU SHOULD HAVE LEARNED FROM THIS CHAPTER

* Lack of a historical durable competitive advantage keeps Warren from investing in emerging industries.
* When Warren considers whether to make an investment in Company X, he asks himself the following question: If the company in question had a market cap of $5 billion and I had $5 billion sitting in my bank account, would it be a wise use of my money to buy the whole company?
* Warren likes to play a little game and pretend that he is going to buy the whole business. He believes that if the entire company isn't worth purchasing at the current stock market price, he shouldn't buy even one share.

Copyright © 2002 by Mary Buffett and David Clark