Anytime I see anything Buffett, I’m inclined to read it. In most cases, it’s a great find, other times, not so much. In this case though… it’s a good one. The Home Run Stocks Bufett Can’t Buy by Anand Chokkavelu, CFA who has a whole plethora of great articles.
How Buffett made his opportunities
Let me take you back to a time when Buffett wasn’t worth 11 figures. Back to a time when he had only five figures to work with.
In his 20s, Buffett’s eventual avalanche was just a snowball. All his name could get him was a dinner reservation … if he called ahead.
So he had to work to find deals to invest in — deals that would form the basis of his fortune. He sought out the master investors of his time, including his hero Benjamin Graham, and learned everything they would teach him.
But more than anything, he did the legwork that others weren’t willing to do. In this time before the Internet, he’d physically go to Moody’s and Standard & Poor’s to read old reports, to the Securities and Exchange Commission to read filings, and to company headquarters to talk with management.
His persistence was rewarded handsomely, particularly in tiny, underfollowed companies. In Buffett’s own words: “I would pore through volumes of businesses, and I’d find one or two … that were just ridiculously cheap.”
How cheap? In one six-year period, he grew his wealth by more than 60% a year. By age 26, he had amassed so much wealth that he considered retirement.
What goes up, must come down…. even Warren Buffett has had some loses..
How Buffett lost his opportunities
Of course, he didn’t retire. In the decades since, he’s continued putting up incredible returns, and he’s laid claim to the unofficial title of greatest investor ever.
But with all this wealth comes a problem.
That problem is exemplified by Buffett’s recent purchase of the Burlington Northern Santa Fe railroad — which he admits wasn’t a particular bargain.
The man who has absolutely throttled the market for more than five decades now says, “Reasonable return is good enough. … I mean, 50 years ago, I was looking for spectacular returns, but I can’t — I can’t get them.”
Why the surrender? One word: size.
Berkshire Hathaway is roughly the size of Wal-Mart now. Buffett’s empire has grown so large that the small multibaggers he used to stalk no longer make a dent in his portfolio’s returns.
For Buffett, analyzing and buying a small-cap stock has roughly the same cost benefit as us walking a mile to pick up a quarter. Instead, he’s stuck stalking elephants like Burlington Northern, which was roughly the size of eBay.
It’s nice to know we have one advantage over Buffett.To take advantage, we have to do the same type of work Buffett did back in his heyday — study the master investors; research the company, its competitors, and its management thoroughly; and dig into financial statements to find strong balance sheets, strong operations, and large margins of safety.
But where to start? To get a list of candidates to start you off, I screened for small companies with low levels of debt and high returns on equity (which gets at strong balance sheets and strong operations, respectively):
Company Market Cap (in millions) Debt/Capital Return on Equity Cooper Tire & Rubber (NYSE: CTB) $1,287 47.9% 33.2% Medifast (NYSE: MED) $380 8.6% 31.7% Suburban Propane Partners LP (NYSE: SPH) $1,909 45.9% 31.3% Cal-Maine Foods (Nasdaq: CALM) $653 23.4% 21.5% Bio-Reference Laboratories (Nasdaq: BRLI) $611 22.4% 19.2% RF Micro Devices (Nasdaq: RFMD) $1,815 34.6% 18.8% Smith & Wesson (Nasdaq: SWHC) $236 32.7% 17.4%
Source: Capital IQ, a division of Standard & Poor’s.
Among the things screening can’t tell you is the quality of management, the competitive pressures the company faces, and the sustainability of earnings. After all this, the price also has to be right for that key margin-of-safety element.