The Warren Buffett Way: The World’s Greatest Investor

(Rick Simeone) #1
The Education of Warren Buffett 25

of searching for companies that were selling for less than their net work-
ing capital, Buffett bought some genuine losers. Several companies that
he had bought at a cheap price ( hence they met Graham’s test for pur-
chase) were cheap because their underlying businesses were suffering.
From his earliest investment mistakes, Buffett began moving away
from Graham’s strict teachings. “I evolved,” he admitted, “but I didn’t
go from ape to human or human to ape in a nice even manner.”^19 He
was beginning to appreciate the qualitative nature of certain companies,
compared with the quantitative aspects of others. Despite that, however,
he still found himself searching for bargains, sometimes with horrible re-
sults. “My punishment,” he confessed, “was an education in the econom-
ics of short-line farm implementation manufacturers ( Dempster Mill
Manufacturing), third-place department stores (Hochschild-Kohn), and
New England textile manufacturers ( Berkshire Hathaway).”^20 Buffett’s
evolution was delayed, he admitted, because what Graham taught him
was so valuable.
When evaluating stocks, Graham did not think about the specif ics of
the businesses. Nor did he ponder the capabilities of management. He
limited his research investigation to corporate f ilings and annual reports.
If there was a mathematical probability of making money because the
share price was less than the assets of the company, Graham purchased
the company, regardless of its business or its management. To increase
the probability of success, he purchased as many of these statistical equa-
tions as possible.
If Graham’s teachings were limited to these precepts, Buffett would
have had little regard for him. But the margin-of-safety theory that
Graham emphasized was so important to Buffett that he could overlook
all other current weaknesses of Graham’s methodology. Even today,
Buffett continues to embrace Graham’s primary idea, the theory of
margin of safety.“Forty-two years after reading that,” Buffett noted,
“I still think those are the three right words.”^21 The key lesson that
Buffett took from Graham was that successful investing involved pur-
chasing stocks when their market price was at a signif icant discount to
the underlying business value.
In addition to the margin-of-safety theory, which became the
intellectual framework of Buffett’s thinking, Graham helped Buffett
appreciate the folly of following stock market f luctuations. Stocks have
an investment characteristic and a speculative characteristic, Graham

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