Thursday, January 5, 2012

The Buffett Test

From a lecture* given by Warren Buffett to Notre Dame faculty, MBA students, and undergraduates in 1991:

You shouldn't buy a stock, in my view, for any other reason than the fact that you think it's selling for less than it’s worth, considering all the factors about the business.

I used to tell the stock exchange people that before a person bought 100 shares of General Motors they should have to write out on a [piece of paper:] "I'm buying 100 shares of General Motors at X" and multiply that by the number of shares "and therefore General Motors is worth more than $32 billion" or whatever it multiplies out to, "because ... [fill in the reasons]" And if they couldn't answer that question, their order wouldn't be accepted.

That test should be applied. I should never buy anything unless I can fill out that piece of paper. I may be wrong, but I would know the answer to that. "I'm buying Coca Cola right now, 660 million shares of stock, a little under $50. The whole company costs me about $32 billion dollars." Before you buy 100 shares of stock at $48 you ought to be able to answer "I'm paying $32 billion today for the Coca Cola Company because..." [Banging the podium for emphasis.] If you can't answer that question, you shouldn't buy it. If you can answer that question, and you do it a few times, you'll make a lot of money.     
- Warren Buffett

What a contrast to the way some buy stocks in today's environment. Investing successfully comes down to being good at estimating what something is worth now, how it's likely to change in value over time, then buying it at a comfortable discount to account for the unforeseeable.

No skillful chartology, macro analysis, sector rotation, momentum, or other similar garbage required.

If the portfolio I just updated in the Tuesday post continues to perform over the long haul, it will be the result of having judged current value and the potential for future value creation reasonably well, and that the stocks were bought with a nice margin of safety.

The rest is distraction.

Adam

* Lightly edited by Whitney Tilson

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