Screening For Buffett & Munger Stocks

9th Nov '22 by Mark Simpson

14 comments 6207 reads

One of the most well-known pivots in investing is the one that made Warren Buffett one of the richest men in the world. Buffett started off working for Ben Graham and initially followed his deep value methods. Buffett described this investing approach in his 1989 Berkshire Hathaway Annual Letter to shareholders:

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.

Despite doing very well employing this strategy, Buffett didn’t always remain a “cigar butt investor”.

The Pivot

In 1959 Buffett met Charlie Munger, then a lawyer in Los Angeles, at a dinner organised by mutual friends. The two men kept in touch and their friendship and business relationship blossomed. Initially, Buffett remained a deep value investor and Munger practised law, but by the 1960s this had a profound impact on both of their lives. For Munger it convinced him to change career:

It took me a long time to wise up that [Buffett] had a better way of making a living than I did. But he finally convinced me that I was wasting my time.

For Buffett, it is Munger he credits with changing his investment philosophy, which is most often summed up in the following quote:

Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.

Given the track record of these investing giants, it would be churlish to dismiss this wisdom. However, followers of Buffett and Munger know that they often like to speak in aphorisms and reality is often a bit more nuanced. Both academic studies and the experience of “cigar butt” investors show that deep value investing can still generate exceptional returns. It is also clear that what the market considers a “wonderful business” changes far more quickly than the business itself.

The biggest issue with “cigar butt” investing is not the returns, but how well it scales, and the temperament required. Indeed, great returns can actually require a strategy shift.…

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Sovereign Individual

9th Nov '22

Hi Mark - Interesting common theme that crops up on your list would be the fund managers e.g. Liontrust Asset Management (LON:LIO) and Polar Capital Holdings (LON:POLR) . An interesting area to look in to i hadn't considered where there is that clear setback now in progress. Thanks

Silver Moon

I'd like to give many thanks to Mark for this series which is helping to concentrate my mind, after all, my 130-plus holdings have the same form as an iceberg, seven-eighths underwater.

Epitychia

Excellent article. Essentially combining high return on capital with growth is the key. Perhaps you can write an article on this theme. A lot of growth stocks have low ROC making them poor prospects.

BnB

This is a great series of articles but the output from the screen is anything but a list of forever stocks! A couple of gems hidden in the manure have something approaching a moat, but I wouldn’t touch the majority with a bargepole. Before anyone lambasts me for giving the author a hard time, I think this is a lot more to do with the pathetic state of British industry than with the limits of the screen. There’s a reason no one got Buffet-rich backing UK plc!

Mark Simpson

I'm not sure about the UK vs the US. This may well be more to do with the size of the "runway" for US stocks versus anything more fundamental.

However, I totally agree with the rest of your points. Finding Buffett & Munger style stocks is hard. This is why I said:

Finding companies that have a sustainable competitive advantage and a long “runway” of opportunities for growth is not as straightforward as using a few simple metrics. It requires getting into the details of how a company operates, generates cash and deploys that capital. Identifying these companies is the genius of Buffett and Munger.

Perhaps I should have been even clearer. I believe this kind of quality investing is analytically the hardest type of investing and requires real understanding at a business level. My aim was to disabuse investors of the notion that this can be done with a few simple metrics. Many investors like the idea of being a Buffett & Munger investor, but far fewer have the analytical skills, work ethic and patience required to actually be that type of investor. I'm not sure I do, to be honest. It is why I'm more of a deep value investor because a) I'm not mega-wealthy and b) it fits my temperament better and c) it's easier (at least analytically, not psychologically.)

So out of this list of stocks, very few will actually have the Buffett and Munger qualities. In future weeks, I will aim to start investors along the journey of looking into a few of these that I think may be interesting. But even then, this will be a primer for further work.

Redpaninvest

A well produced and thought through article!

Yep...metrics help but aren't the fix all solution. Yep, backing a good business is key but you can't always tick all the boxes.

Mmm. Coca Cola...it'd be interesting to see how that racks up pre and post Buffet acquisition. A moat with dozens of other makers' moats but for sure a long runway!

Thanks for the thoughtful reply. I think the other point worth weighing up is whether any of us have the balls to hold such concentrated positions as Buffet in his glory years. I may have concentrated my assets when I was owner of my own business but that was with the benefit of the most privileged access to the company's performance AND its owner's intentions. More to the point, that was before achieving sufficient scale to find a willing buyer at the right price. Once that was ensured it was with great relief that I distributed my wealth across a wide-ranging portfolio, guaranteeing an index-like performance*.

I have indulged in the thought experiment of condensing 200 positions into 20 highest conviction picks. And the idea appeals for reasons of achieving scale in my investing side-hustle - generating income out of derivatives on the underlying - I've sold a lot of calls this year. But conversations with my advisor reveal that his other clients with similar exposures to reliably growing, high ROIC, high margin businesses across a far more concentrated base are experiencing the same returns. In other words they are not outperforming for the added concentration-risk.

Maybe after living with my moaty names for a while longer I'll be ready to roll competing names into one "winner" just at the point they look like a "loser". But firstly I need to get better at investing full stop!

* Unfortunately the index my performance most resembles in '22 is the Nasdaq, even if the crossover is less than 15%.

Aargh Aitch

My antenna twitched when I spotted 2 which I hold on the list (Don't get too excited I'm not solid-gold-toilet-seat wealthy, yet...), whilst, ahem, being "Surprised" at the presence of others, as well as ones which I'd contemplated but not invested in, in some cases because I just didn't understand their businesses. I recall that being a Buffettism; don't put your money in a businesses who's product you can't understand. For me- and I suspect others- that'll help whittle the screen of 51 down nicely.

Incidentally, I only know the gist of the American Express Salad Oil scandal but as related by Roger Lowenstein "Buffett the making of an American capitalist", the liability was uncertain yet the Chief Exec Howard Clark, decided that refunding the creditors was the right thing to do. The implicit message being that Clark (And the as yet uninvolved Buffett), understood that Amex's protective moat was it's reputation, "The public trust was all" (p80). That retelling of the incident might have been neatened up a bit to reflect the slight "Mr Smith Goes To Washington" aura that Buffett has but it highlights that the moat, the thing, that elevates a business over it's industry rivals might be completely intangible in the broadest sense. Something that could never be snagged by a quantitative screen alone.

doctor dave

I think, though, this is a screen from which to pick one or maximum two long-term moaty holds.

But if the screen lets a lot of junk through then it’s clear that the secret sauce lies outside the parameters adopted within the filter. Again, that’s not to criticise the author. It’s an illustration of how difficult it is to reduce a moat to numbers.

Personally I prefer to look for the moat first - network effects, stickiness, scale, IP, brand, regulation, lower costs - and then identify whether the business has the operating numbers and track record to back it up.

timarr

10th Nov '22

Many investors like the idea of being a Buffett & Munger investor, but far fewer have the analytical skills, work ethic and patience required to actually be that type of investor.

Spend any time studying the psychology of superinvestors and you discover that they're not normal. They have unusual psychological makeups which means they're less affected by the various behavioural biases that dog most of us. They don't all invest in the same way, but they're all capable of handling the vicissitudes of markets without the kind of angst that most people suffer.

So even if you could perfectly replicate their thought processes through a screen you couldn't replicate their response to events. And, because of that, everyone needs to figure out their own way of dealing with these, which inevitably means not exactly copying anyone else.

Of course, many people can't do this and instead spend their time looking for advice from strangers. That doesn't tend to end well, no matter how well meaning the guru.

FWIW - and that's very little - I hold ten of the stocks thrown up by that screen. For the most part that's because I think they're reasonable businesses at depressed prices rather than because they're standout investment opportunities. The likes of like Burberry (LON:BRBY), Dr Martens (LON:DOCS) and Games Workshop (LON:GAW) clearly do have some kind of moat but most just look like fairly standard GARP companies, at cheapish prices.

The likes of like Burberry (LON:BRBY), Dr Martens (LON:DOCS) and Games Workshop (LON:GAW) clearly do have some kind of moat

Those are the ones I had picked out. But of those, I’d argue that only Games Workshop genuinely has a decent moat. Burberry is an also-ran in the world of high fashion and DMs drift in and out of favour.

This is a good point on concentration risk, and one I hope to talk a bit about in my next article.

In my book, I describe how even Buffett may have been overconfident and too concentrated at times. He himself admits that his current success is dependent on one or two risky decisions going his way, and if they hadn't they would have had a very material outcome on his success.

MichaelFBS

11th Nov '22

Thank you for a great article.

Regards

Michael

Screening for Buffett & Munger Stocks

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Mark Simpson

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