Warren Buffett: The Easiest Way To Value Stocks

Summary

In this insightful discussion, Jeff Colbert from Olathe, Kansas, seeks advice on improving business valuation skills. Warren Buffett emphasizes the importance of understanding a company's intrinsic value and applying a margin of safety, a principle he learned from Benjamin Graham. Charlie Munger adds that recognizing durable competitive advantages is key, but also acknowledges the value of avoiding competition. Both stress the significance of continuous learning and self-awareness in one's circle of competence. They highlight that businesses requiring minimal capital, such as consumer and service businesses, are particularly attractive, and touch upon the concept of businesses operating with negative capital. The conversation underscores the value of discipline, curiosity, and the pursuit of knowledge in the world of investing.

Takeaways

• 📈 Jeff Colbert started investing in 1999, learned the hard way about valuing businesses and applying a margin of safety.
• 🛠 Warren Buffett emphasizes the importance of understanding a business's value and having a margin of safety, as taught by Benjamin Graham.
• 🔍 Charlie Munger highlights the value of a durable competitive advantage and a first-class business, but also acknowledges that many businesses are not well understood even by experts.
• 🚫 The key is knowing the perimeter of your circle of competence; it's not about being an expert on many businesses, but understanding those you invest in.
• 🤔 Buffett suggests thinking about businesses in your own hometown, considering their economics, longevity, and competitive strength to enhance your valuation skills.
• 💡 Munger advises learning from observing businesses and asking questions about their operations and economics from a young age.
• 🌐 Buffett mentions that opportunities arise occasionally, and one should be ready to seize them, even in unfamiliar markets like Korean stocks, provided they meet the margin of safety criteria.
• 🧠 The importance of continuous learning and adapting to a changing world is stressed, as it's crucial to improve in a competitive field like investing.
• 🏆 Munger shares that success in business often comes to those who are disciplined, avoid trouble, and focus on doing things right, rather than those who are already wealthy.
• 🏦 Buffett discusses the concept of businesses operating with negative capital, where customers pay in advance, which can be very profitable.
• 💰 The best businesses are those that require minimal capital to operate and can grow significantly, such as consumer businesses where customers pay upfront.

Q & A

What investment philosophy did Jeff Colbert initially adopt?

Jeff Colbert initially adopted the 'Buy and Hold' philosophy, which involved not worrying about market price fluctuations and not applying a margin of safety or valuing a business.

What is the importance of understanding the value of a business and applying a margin of safety according to the transcript?

Understanding the value of a business and applying a margin of safety is crucial as it helps investors avoid significant losses and make informed decisions, which can lead to more successful investments.

What did Warren Buffett learn from Ben Graham about valuing companies?

Warren Buffett learned from Ben Graham a method to value a certain type of company that would prove successful, although the universe of those companies eventually dried up.

What concept did Charlie Munger teach Warren Buffett about businesses?

Charlie Munger taught Warren Buffett about the value of a durable competitive advantage and the importance of investing in really first-class businesses.

Why is it important to know the perimeter of your circle of competence according to Warren Buffett?

It's important to know the perimeter of your circle of competence because it helps investors understand their limitations and focus on businesses they truly understand, which is crucial for making sound investment decisions.

What is the significance of continuously learning and asking questions about businesses?

Continuously learning and asking questions about businesses helps investors extend their knowledge over time, understand different types of businesses better, and make more informed investment decisions.

What did Warren Buffett consider when looking at Korean stocks?

Warren Buffett considered the margin of safety test when looking at Korean stocks and diversified his investments because he didn't know much about any specific business but knew the package of 20 would work out well.

What is the key to getting better at something competitive according to the transcript?

The key to getting better at something competitive is to think about it a lot, learn a lot, practice doing it a lot, and keep learning because the world and your competitors keep changing.

What did Charlie Munger learn from observing the businesses in Omaha as a child?

Charlie Munger learned about the importance of avoiding competition, doing things right, and having discipline by observing businesses in Omaha, including how some businesses failed while others rose to success.

What is the difference between the capital necessary to run a business and what Berkshire might have paid for the business?

The capital necessary to run a business refers to the actual capital required for the business operations, whereas what Berkshire might have paid for the business is the investment amount that determines whether it's a good investment.

What type of businesses are considered to have the best return on capital?

Businesses that require very little capital to operate and can grow large, such as consumer businesses where people pay in advance like magazines or insurance, are considered to have the best return on capital.

What does Charlie Munger believe is the key to gradually learning about businesses and investing?

Charlie Munger believes that asking questions about reality, understanding why things work or fail, and having the right temperament to learn from experience are key to gradually learning about businesses and investing.

Outlines

00:00

😀 Learning from Failure and Valuing Businesses

Jeff Colbert from Olathe, Kansas, shares his experience starting in investing in 1999 before the tech bubble. He learned the hard way about the importance of valuing businesses and applying a margin of safety, as taught by Charlie Munger and Warren Buffett. The key to improving in valuing companies is to understand the types of businesses one is investing in, knowing one's circle of competence, and continuously learning. Buffett emphasizes the importance of recognizing limitations and learning from experience, including looking at businesses in one's hometown and considering their economic prospects over the long term. He also mentions his experience with Korean stocks, which taught him about finding opportunities with a margin of safety.

05:01

😀 Avoiding Competition and Learning from Early Influences

Charlie Munger reflects on his early experiences and how they shaped his approach to valuing businesses. He recalls an old man at the Omaha Club who prospered by avoiding competition, which sparked his curiosity about business. Munger and Buffett discuss the importance of discipline, doing things right, and avoiding trouble. They mention individuals like Pete Kiewit, who rose from small beginnings and were successful due to their approach to business. The conversation highlights the idea that success in business is not just about avoiding mistakes but also about having the right temperament and continuously learning from experiences, which is a gradual process.

10:01

😀 Capital Efficiency and the Quest for High Return Businesses

The discussion shifts to the concept of return on capital, with a question about which business has had the best return for Berkshire and in general. Buffett explains the difference between the capital necessary to run a business and the capital one might pay for it. He cites examples of businesses that operate with negative capital, such as magazines, and those that require very little capital, like Apple. The ideal business, according to Buffett, is one that can grow large without needing additional capital. Munger adds that businesses where customers pay in advance, using their capital, are particularly attractive. The conversation underscores the importance of capital efficiency and the competitive nature of the market for such businesses.

Keywords

💡Investing

Investing refers to allocating resources, typically money, with the expectation of generating an income or profit. In the video's context, Jeff Colbert began investing in 1999, just before the tech bubble, indicating the importance of timing and strategy in investment decisions. The theme of investing is central to the video, as it discusses approaches to valuing businesses and applying a margin of safety, which are fundamental to successful investing practices.

💡Buy and Hold

The 'Buy and Hold' strategy is an investing approach where an investor purchases stocks and holds onto them for a long period, regardless of market fluctuations. Jeff Colbert mentions learning this strategy early on, which suggests a passive investment style. However, he later emphasizes the importance of business valuation and margin of safety, indicating a shift towards a more analytical and active approach to investing.

💡Margin of Safety

Margin of safety is a principle in investing that suggests buying a stock at a price significantly lower than its estimated intrinsic value, providing a buffer against loss. The concept is highlighted by Charlie Munger, who advises on the importance of this principle in valuing a business and making investment decisions. It underscores a cautious and value-oriented approach to investing.

💡Circle of Competence

The 'circle of competence' is a concept that emphasizes the importance of staying within one's area of expertise when making investment decisions. Warren Buffett explains that it's not the size of the circle that matters but knowing its perimeter. This concept is crucial as it encourages investors to focus on businesses they understand well, thereby reducing risk and increasing the likelihood of successful investments.

💡Durable Competitive Advantage

A durable competitive advantage refers to a business's ability to maintain a long-term edge over its competitors, often due to factors like brand recognition, proprietary technology, or cost leadership. Charlie Munger discusses this concept, indicating that businesses with such advantages are more likely to succeed and are worth considering for investment.

💡Business Valuation

Business valuation is the process of determining the economic value of a business or company. It is a key concept in the video, as both speakers discuss the importance of understanding a business's economics before investing. Accurate valuation is essential for applying the margin of safety and making informed investment decisions.

💡Capital

In the context of the video, 'capital' refers to the money or assets invested in a business to finance its operations. The discussion around return on capital (ROC) highlights the importance of understanding how efficiently a business uses its capital to generate profits. Businesses that require less capital to operate are often seen as more desirable investments.

💡Return on Capital

Return on Capital (ROC) is a measure used to evaluate the efficiency and profitability of a business in relation to the capital invested in it. The video discusses the concept of ROC in the context of evaluating businesses, with the implication that higher ROC indicates better investment opportunities.

💡Monopoly

A monopoly is a market condition in which one company has exclusive control over a product or service. The video touches on the concept of monopoly power in relation to pricing power, suggesting that businesses with such power can dictate prices and are often highly profitable, making them attractive investment targets.

💡Pricing Power

Pricing power refers to a company's ability to set prices for its products or services without losing customers to competitors. In the video, it is associated with monopolies or near-monopolies, indicating that such businesses can generate significant profits and are valuable from an investment perspective.

💡Consumer Businesses

Consumer businesses are companies that sell products or services directly to the end consumer. The video mentions that great consumer businesses often require relatively little capital, making them attractive for investors. Examples given include Apple and See's Candies, which are successful due to their strong brand and consumer loyalty.

Highlights

Jeff Colbert from Olathe, Kansas, shares his early investing experience and the lessons learned from the tech bubble.

The importance of valuing a business and applying a margin of safety is emphasized by Charlie Munger.

Warren Buffett discusses the evolution of his approach to valuing companies, from learning under Benjamin Graham to understanding various business types.

The concept of 'circle of competence' is highlighted, stressing the need to know the perimeter of one's expertise.

Buffett advises on the approach to improving business valuation skills, suggesting self-reflection and discussion with others.

Munger shares anecdotes from his childhood that influenced his understanding of business and competition.

The value of discipline and doing things right is underscored as a key to success in business.

Buffett and Munger discuss the unpredictability of business success and the importance of individual character.

Munger's early business education and his father's influence on his understanding of business valuation.

The significance of avoiding obvious mistakes in business and investing is highlighted by Buffett.

Buffett explains the difference between the capital necessary to run a business and the capital paid for the business.

Examples of businesses that operate with negative capital, such as magazines and insurance companies, are given.

The desirability of businesses that require minimal capital, like Apple and See's Candies, is discussed.

Buffett and Munger agree on the importance of continuous learning and adapting in the business world.

The concept of pricing power and its relation to monopoly or near-monopoly businesses is explored.

Buffett and Munger avoid naming specific businesses with the best return on capital to prevent the appearance of promoting monopolies.

Transcripts

hello my name is Jeff Colbert and I'm

from Olathe Kansas

I got started in investing in 1999 right

before the big Tech bubble and

unfortunately I learned Buy and Hold and

uh

don't fret about market price

fluctuations before I learned the

importance of valuing a business and

applying a margin of safety

so as Charlie said I got my feet wet

with huge failure right away

and we're in the club

thank you I don't feel so bad now

um

so that leads to my my question it seems

like to I've read all the Berkshire

reports and all the reading I can do

about you two and and I thank you for

these wonderful meetings but

it seems like it boils down to some

simple things valuing a business and

applying a margin of safety so my

question is what do you recommend for an

approach to getting better and better at

valuing companies

you know it's a very very good question

and in my own case

you know I started out without doing

anything about value in companies

and then Graham

taught me a way

to

value a certain type of company

that would prove successful

except the universe of those companies

dried up but nevertheless it it was

almost a guarantee against failure but

it wasn't it was not a guarantee that

these things would continue to be

available Charlie taught me about a lot

about the value of a durable competitive

advantage and and a really first class

business

but

over time

I've learned more about various types of

businesses but you do be amazed how many

businesses I don't feel that I

understand well

the biggest thing is not how big

your circle of competence is but knowing

where the perimeter is if you

you don't have to be an expert on ninety

percent of the businesses or 80 or 70 or

50. but you do have to know something

about the ones that you actually put

your money into and if that's a very

small part of the universe

that still is not a killer and

I I think if you think about what you

would pay for a McDonald's stand was you

think you would pay for you know think

about the businesses in your own

hometown of the Laughing uh

you know which would you like

to buy into which do you think you could

understand their economics which you

think will be around 10 or 20 years from

now which you think it would be very

tough to compete with just keep asking

yourself questions about businesses talk

about with other people about them you

will extend your knowledge over time and

always remember that margin of safety

and I think you basically have the right

attitude because you do you recognize

your limitations and that's enormously

important in this business you will find

things to do six or seven years ago

maybe not that long yeah six or seven

years ago when I was looking at Korean

stocks for example I never had any idea

that Korean stocks would be something

that I would be buying but I looked over

there and and I could see that there

were a number of businesses that met the

margin of safety test and there I

Diversified because I didn't know that

much about any specific one but I knew

that the package of 20 was going to work

out very well even if a crook might run

one of them and a couple of might run

into competition I didn't anticipate

because they were so cheap

and that was sort of the old Graham

approach uh you will find Opportunities

from time to time and the beauty of it

is you don't have to find very many of

them currently

well obviously if you want to get good

at something

which is competitive

you have to think about it a lot and

learn a lot and practice doing it a lot

and the way the world is constructed

in this field you have to keep learning

because the world keeps changing

and your competitors keep learning

so

you just have to get up each morning and

and

try and go to bed that night a little

wiser than you were when you got up and

if you keep doing that for a long time

and

and accumulate some experience good and

bad as you try and master what you're

trying to do

people do that almost never fail utterly

they may have a bad period

when luck goes against them or something

but very few people have ever failed

with that

with that uh if you have the right

temperament

you may rise slowly but you you're sure

to rise

Charlie did you take any business

courses in school no I took accounting

and

when did you start valuing businesses

and how did you go about it

when I was a little boy

I can remember I would come down to the

Omaha club and it was an Old Gentleman

who hit the Omaha Club about 10 30 every

morning he obviously did almost no work

and yet was quite prosperous

well but he made me very curious as a

little boy I said to my father how in

the hell does he do that

and he said Charlie he's in a business

where he enjoys practically no

competition he gathers up and renders

dead horses

well that was an example of avoiding

competition by one stratagem

and if you keep asking questions like

that of reality

starting at a young age you gradually

learn

and where you were doing the same thing

yeah thankfully he extrapolate he went

beyond his original

insight there but

I noticed it's rather interesting

you take the rulers of the

businesses when I was a little boy

a awful lot of those business in Omaha a

lot of those businesses went broke a lot

of them sold out at modest prices under

distress

and some of the people who Rose

like key Whit from Small Beginnings

nobody thought of as the great glories

of of that early time

and I think that's kind of the way life

is

it's hard to get anywhere near the top

and it's hard to hold any position once

you've attained it

uh

but

I think you could predict

the key what was likely to win

they cared more about doing it right

they cared more about avoiding trouble

they put more discipline on themselves

if you knew the individual well you

would have you would have been right

what if you knew the individual

Peterson I would not have bet on any of

the people I knew who were already

wealthy

but I would have bet on Pete Kiewit his

sister taught me math

and and

no half Dutch half German you know this

is a tough culture and there's your

there you've just heard it folks half

Dutch half German

go out looking for him

well the man was recommending this is

named monger and anyway the uh

uh no I I don't think it's that but if

you're

I was just automatically doing it what

was working

what was failing why was it working why

was it failing if you have that

temperament

you are gradually going to learn

and and uh if you don't have that

temperament

I can't help you

if you'd followed Peak human around for

10 years you never would have seen him

do anything dumb right

yeah and so

it it's avoiding the dumb thing you

don't it really don't have to be

brilliant but yeah you know you have to

avoid just sort of what almost seemed

the obvious mistakes but I would say

that you're on the right track back

there on the in in terms of

having the basic fundamentals knowing

your limitations but still seeking to

learn more about various kinds of

businesses surely

I think when he practiced law

any client that came in Charlie was

thinking about that businesses if he

owned the place

and he probably generally felt he knew

more about the place and the guy that

actually owned it who was his client who

was the client but but I remember

talking to him

you know 50 years ago and he would start

talking about caterpillar dealerships in

Bakersfield or something of the sort it

was it was incapable of looking at a

business without thinking about the

fundamental economics of it

how'd that guy do with the caterpillar

well

he sold it for appropriately ridiculous

price to a dumb oil company

it wasn't worth half what he got for it

yeah

but they had a concept they had a

concept in the strategy and no doubt

they had Consultants

all right

Becky

this question comes from Carson Mitchell

in Aberdeen South Dakota who asked both

of you what business has had the best

return on capital for Berkshire and what

business of any on Earth has had the

best return on Capital and he adds PS I

would have come by rail but there are no

seats in the grain rail cars

they

there's two ways of looking at it if you

talk about the capital necessary to run

the business as opposed to what we might

have paid for the business I mean the if

we buy a wonderful business you could

run the Coca-Cola Company assuming you

had the bottling systems ever you could

run it with no capital

yet now

if you buy it for a hundred billion

dollars I mean you can look at that as

your capital or you can look at the

basic Capital we when we look at what's

a good business we're defining it in

terms of the capital actually needed in

the business whether it's a good

investment for us depends on how much we

pay for that in the end

there are a number of businesses

that operate on negative capital

uh

Carol's with Fortune Magazine you know

any any of the great magazines

and

operate with negative capital I mean

they the subscribers pay in advance

there are no fixed assets to speak of

and and the receivables are not that

much the inventory is nothing so

a magazine business my guess is that

People magazine operates or Sports

illustrate Opera Sports illustrator

operate with negative capital

and

particularly people make a lot of money

so there are certain businesses well we

had a company called Blue Chip Stamps

that that where we got the float ahead

of time and operated with

really substantial negative Capital uh

but there are a lot of great businesses

uh

that need very very little Capital Apple

doesn't need that much Capital that you

know that uh

the best ones of course are the ones

that get very large while needing no

Capital C's is a wonderful business

needs very little capital

but it we can't get people eating 10

pounds of of boxed chocolates every day

except here we want to

uh

generally the great consumer businesses

need relatively little Capital uh

um

the the businesses where people pay you

in advance you know magazines of

Christians being a case Insurance being

a case

uh you know you're using you're using

your customers capital

uh and we like those kind of businesses

but of course so does the rest of the

world so they can become very

competitive and and buying them we have

a business for example this won't run

wonderfully uh like Catherine Kathy

Baron Tamara is called Business Wire

Business Wire does not require a lot of

capital it has receivables and

everything but it is a service type

business and many of the service type

businesses and consumer type businesses

require a little capital and when they

get to be successful

you know they can really be something uh

Charlie

I've got nothing to add but

at any rate they

the formula never changes

if you get on if you get on one business

in the world what would it be Charlie

I hope I already own them myself

you and I got in trouble by addressing

such a subject many decades that's right

I don't think I'll come back to it okay

number 13. if you name some business

that has incredible pricing power you're

talking about a business that's a

monopoly or near Monopoly sure and I

don't think it's very smart for us to

sit up here

naming is our most admired business is

something that other people regard as a

monopoly okay we'll move right along