Everyone who invests wants to be good at it. We all think we are smart enough to figure out what stock or what fund will make us money. If you are like me, you do your research, determine how the business is performing, asses the stock price and then decide if you are going to buy the stock or not. I spend a great deal of time researching stocks, yet I have never had anywhere near the success of Warren Buffett. I have read a number of books about Buffett, have listened to his lectures that are available on YouTube and watched his interviews on CNBC and other media sites. Yet, I have been unable to gain the market insight and/or stock picking ability Buffett has shown through his long investing career.
During the last week I have spent some time doing some additional research on Buffett. I have read his annual Berkshire letters and watched some interviews. After completing this research I came up with five traits Buffett has that I need to incorporate, or improve on. I am sure there are more than five, but these are the five that stood out to me.
1 - Stop Caring What Other People Think - Have you ever watched an investing show on television, or listened to one on the radio and heard a question like this. "Hi, I just bought XYZ stock, what do you think of it?" That is a call Buffett would never make. Warren Buffett does not care what anyone else thinks, he only cares what he thinks. In the mid-1990's Buffett bought a large stake in American Express (AXP). At the time American Express was reeling, their brokerage company was losing money and their credit card business was losing market share. This is how Fortune magazine described AXP at the time
"A nearly dysfunctional management team led by James Robinson III damaged the brand in the early 1990s; his grand strategy to build a financial supermarket fell like a house of cards, with Amex's Shearson Lehman brokerage subsidiary eating up $4 billion in capital before being sold last year. More recently the tarnished American Express card has been losing market share to Visa and MasterCard as Amex's principal consumer benefit--prestige--becomes a tougher sell. And the company's international business, say analysts, is in the doldrums."
Despite the above description, Buffett bought AXP and kept buying, eventually owning more than 49 million shares. Buffett was second guessed for his purchase of AXP, all anyone could see was the difficulties AXP was having, not the potential. Here is another quote from the same Fortune article. "When Buffett comes up aces, it's usually because he's backing a strong management hand. What's hard to see this time around is how a bunch of consultants can rake in the pot in a truly cutthroat game." As we all know Buffett was proven right as his big bet on AXP has produced huge returns for Buffett.
I confess that when I research stocks I look to see what others think. Lately, when I research a company I find myself checking a couple authors at Seeking Alpha to see what they have to say. I also check a couple of other websites where I can read research reports. I also admit, what I have read at times has changed my opinion on a stock I wanted to buy. Going forward this is the Buffett quote I am going to try and follow. "You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right - that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else.'
Do your research and trust your judgment. The opinion of the guy on the radio, the website, or on television, is no more valid than yours.
2 - Learn To Be Comfortable Doing Nothing - I admit that I always have the feeling I should be doing something. Not a day goes by where I don't wonder if I should buy something or sell something. I have this inner fear I am missing something. Somewhere there is a cheap stock that I could buy is a common thought of mine. As I wrote in this article, I have learned from past mistakes, that I would have many times been better off not doing anything, than take the action I did. Despite that, I continue to fight my urge to do something. Unlike me, Warren Buffett is very comfortable doing nothing. Here is a quote from Buffett that describes his philosophy. You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.'
Waiting for the opportunity is the hard part because every day there is an article in the paper or on some website about some great stock that should be bought. I come to Seeking Alpha every day and every day I read articles, many of them bullish pieces on some company the author believes is worth buying. When I tune to CNBC there is analyst talking about a good opportunity in some stock. All this noise is hard to turn off, but it needs to be turned off. The best poker players are not the ones that play every hand; it is the ones that wait to play a hand that gives them the best chance to win. That is the way investing should be looked at, wait for the best opportunity and then take action.
In 1999 Warren Buffet's company Berkshire Hathaway (BRK.A) was inactive in the stock market. At this time the market was flying high as we were in a tech bubble and equities had spent most of the 1990's going up. Here is what Buffett said about his inactivity in his 1999 newsletter.
"Our reservations about the prices of securities we own apply also to the general level of equity prices. We have never attempted to forecast what the stock market is going to do in the next month or the next year, and we are not trying to do that now. But, as I point out in the enclosed article, equity investors currently seem wildly optimistic in their expectations about future returns."
He went on to add this.
"Berkshire will someday have opportunities to deploy major amounts of cash in equity markets -- we are confident of that. But, as the song goes, "Who knows where or when?" Meanwhile, if anyone starts explaining to you what is going on in the truly-manic portions of this "enchanted" market, you might remember still another line of song: "Fools give you reasons, wise men never try."
Buffett did not care that the entire year went by and he add done little. He was going to wait for the right opportunity and as he predicted, the opportunity did come as stock prices fell greatly in 2000. Opportunity doesn't come every day or even every month, be patient and wait for the opportunity that the market will eventually give you.
3 - Invest for the Long Term - I like to think of myself as a long term investor, but the truth is over almost 40-years of investing I have only held a few stocks for a long time. I first bought McDonald's (MCD) in 1994 for an average of approximately $26.00 a share; I would hold it until 2000 when I sold it for $40.60. While I owned the stock, it had a 2 for 1 split. Despite the fact the business was in good shape and the stock price momentum was fine, I sold it. Why did I sell it? I sold it because I wanted to buy WorldCom. I do not have to tell you how that turned out. That is a move Warren Buffett would never make. When Buffett buys a stock, he intends to hold forever, as he stated in this well-known quote. "Our favorite holding period is forever"
Buffett started buying Coca-Cola (KO) in 1988 and he has never sold a share. During those 25-years of ownership KO has gone through some rough times. They have had some poor CEO's and had some periods of disappointing sales, yet Buffett never sold. Buffett bought Wells Fargo (WFC) in 1990 and American Express in 1991. Those two financial stocks have gone through several rough periods, especially the 2008/2009 financial crisis. Buffett always seeing the big picture did not panic and sell, in fact he bought more WFC. He knew the crisis would not last and he knew that both Wells Fargo's and American Express's business would survive and eventually recover to their previous health.
Buffett often states "If you don't feel comfortable owning something for 10 years, then don't own it for 10 minutes." That is a philosophy I am trying hard to follow. I bought Exxon Mobil (XOM) shares from 2008 through 2009, sold a small amount in 2011 but have held ever since. I bought McDonald's shares in 2008 and have held ever since, even adding some in 2011 and 2012. I bought Coke shares in 2010 and 2011 and have held ever since. I bought Walgreen (WAG) and Kinder Morgan (KMI) shares in 2012 and have held all the shares I bought and recently added to my KMI shares.
Those five stocks are my largest holdings and I intend to hold them for as long as the business of each company performs well. Each of those companies has, at some point, had a rough patch. KMI was recently publicly attacked by a short seller which dropped the price. I used that opportunity to buy quite a bit more. As I research stocks now, the question I always ask myself is, am I willing to own this for 10 years or longer, if not, I will not consider it. As Buffett has said "'Time is the friend of the wonderful company, the enemy of the mediocre."
In a previous article I wrote, I described great companies as glaciers, over time gaining market share, entering new markets, growing earnings and increasing dividends. Like glaciers, great companies with great businesses move slowly, but steadily forward. Buy great companies and hold them, time will take care of the rest.
4 - Look At and Value the Business, Not the Stock - What is a stock? It is a company's name and ticker symbol with a price next to it. Warren Buffett doesn't concern himself with the stock or the price action. Buffett has stated
"For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it's going up.'
Buffett starts his analysis by looking for a business that has a sustainable product or service, a solid balance sheet and a business that has a moat. He also prefers companies that are relatively simple to explain. He often has stated "'Never invest in a business you cannot understand". Buffett advice is to 'Buy companies with strong histories of profitability and with a dominant business franchise"
Buffett's describes the next step as the most important "The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.' Once Buffett finds a company that fits in his comfort zone, he then assigns a value to it. If it is a bargain he will buy it, if it isn't he waits until it becomes a bargain. Sounds simple, but it isn't.
Of my five largest holdings, I can easily describe each business and why I own it. Coca-Cola, McDonald's, Walgreen, Exxon and Kinder Morgan are all relatively simple businesses. However, assigning an intrinsic value to the businesses is not as easy. You can look at P/E or Price to Earnings Growth (PEG) but those valuation indicators can be misleading if the company has a disappointing or exceptional quarter. As Buffett has said, "Valuing a business is part art and part science" I am comfortable saying I will never be as good as Buffett at assigning value to the business, but that doesn't stop me from trying.
I do look at P/E. usually through a historical comparison; I look at PEG, at debt ratios, and other commonly used metrics. However, for the most part I rely on my gut and fundamental analysis. I like to listen to conference calls and even better are analyst presentations. During the webcast I like to hear what managements forecast for the business is. I have found that management is usually relatively honest when discussing forward looking results. If the business is struggling, you will hear descriptions like, "we face challenges", or "we have work to do". If business is going well, they will be upbeat and use terms like, "we are very happy with our performance, but not content", or "we are executing on our vision". Once I hear the conference call or analyst presentation I will assess how management described the business and how the market is valuing it.
The best example I have of this working is back in early 2012 when Walgreen fell to below $30.00. WAG had just bought Alliance Boots and was stuck in a dispute with Express Scripts (ESRX). Analyst criticized the Alliance Boots acquisition and the Express Scripts dispute was hurting quarterly earnings. Listening to management at an analyst presentation, WAG management described how the Alliance Boots acquisition would be immediately accretive to earnings and how the ESRX dispute would be temporary. After the presentation I thought the future for WAG looked promising and could not believe the P/E was under 10. Earnings the year before had grown over 20%. I decided the business wasn't being valued correctly and bought a full position at $29.80. A year and half later, I am very happy and still like the future for WAG.
Not all my analysis ends so well, but I keep trying and keep focusing on the business. As Buffett has said "If a business does well, the stock eventually follows"
5 - Understand the Power of Dividends - Recently Warren Buffett was on CNBC with Bank of America (BAC) CEO Brian Moynihan. During the interview CNBC reporter Becky Quick asked Mr. Moynihan if he was going to call the high yield preferred stock that Buffett owns in BAC. Mr. Moynihan replied no he was not going to call the preferred because Buffett's money was helping BAC pay off other higher cost debt. Mr. Moynihan then added, "One thing you learn quickly about Warren is he loves the cash yield". Becky Quick then asked Buffett if he was considering exercising the BAC warrants he owned. He responded that there was no reason to exercise the warrants, unless the common was paying a high yield.
In Buffett's 2010 shareholder letter to investors Buffett wrote this.
"Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn't be surprised to see our share of Coke's annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business."
I believe those two examples show that Warren Buffett loves to receive dividends. He loves dividends because it gives him more cash to put to work. For you and me it is no different. Dividends are cash in your account that you can use several ways. Assuming you don't need the cash for living expenses, you can automatically reinvest the dividends back into the same stock that paid the dividend. This increases the number of shares you own in the company and also lowers your cost basis. Or, as I do, you can let the dividends accumulate and then use the money to buy additional shares of a company you already own, or buy shares in a company you don't currently own.
As Buffett described when talking about his Coke dividends, strong businesses normally increase their dividends yearly. If you hold the stock long enough, the dividends you receive from the company can start to repay what you originally invested in the company. I have held McDonald's shares since 2008, in those 5-years of ownership; MCD has paid dividends that amount to approximately 20% of what I originally invested. I intend to hold MCD forever, or until the business falters, so I expect at some point that the dividends will return my original investment back to me.
Learn to value dividends, they are your share of the company's profits. Take the money your investment is giving you and use that money to grow your investments. A single flower can multiply over time by dropping seeds. A portfolio can multiply over time by using the seeds of dividends to grow.
Applying These Lessons to Microsoft
As I write this Monday morning, the market is down slightly for the day and down a small amount from the yearly high. The markets remain up double digits for the year with the NASDAQ up over 20%. In recent interviews, both Warren Buffett and Carl Icahn have stated they do not see any bargains in the market. However, applying lesson one, stop carrying what others think, I do see a bargain.
Microsoft (MSFT), which is the top company on my watch list, has all the qualities Mr. Buffett likes. It has a rock solid balance sheet, it is a well known brand, and has a huge moat in many of its business lines.
Lesson 1 - If you mention MSFT to most people they will probably say outdated technology, getting killed by Apple (AAPL), Google (GOOG) and others. However, we do not care what they think because we have done our research and know that is wrong. Here are a few business lines that show MSFT is alive and very well.
- Windows 8, supposedly a failure, has sold over 100 million licenses to date.
- 50% of S&P 500 companies use Windows Azure, with revenues growing 200%.
- Bing's U.S. search share is up from single digits to 17.86% and advertising on Bing is up 32%
- Xbox Live has over 48 million users.
- Office 360 has 1 million users and is growing.
- Internet Explorer is still the leading browser with 56.5% share worldwide.
- Double digit revenue growth in SQL server, System Center, Exchange, CRM, Lync and SharePoint.
- Strong share gain in Enterprise Cloud.
- Windows phone up 900% in Latin America, 400% in India, 300% in China, 300% in Asia Pacific and 700% in Middle East & Africa.
Those are just a few of the businesses where Microsoft is performing just fine. So we can let people think MSFT's best days are behind it, we know that is not true.
Lesson 2 - is we only want to act when there is opportunity, I believe MSFT's current valuation is a long term compelling opportunity that has the traits Buffett likes. A strong business with a moat, selling at a fair value, with a healthy and growing dividend. A patient long term investor will be rewarded owning the company.
Lesson 3 - An investment in MSFT would be a long term investment. Microsoft is in the middle of a restructuring where they are rearranging their business lines in the hopes it allows for quicker product development and reaction to market conditions. Business restructurings do not provide quick improvements in results. But, overtime, if done right, restructuring can improve results.
Microsoft is a large company that has dominant share in many technology sectors. Having a commanding market share in various sectors offers the company the chance to leverage that share into market share gains in other sectors. For example, Microsoft's dominant Office product has helped fuel growth in their SkyDrive storage product. In addition, large companies ,like MSFT, with huge balance sheets can buy other up-and-coming technologies. These advantages allow a company to grow over time.
Microsoft is growing and will continue to grow.
Lesson 4 - Valuing the business. As I highlighted above, MSFT has many business lines that are growing rapidly. However, it does have business lines that are under performing. The top business issue currently is the slow down in PC's sales. The move to more mobile devices has MSFT behind in that area. However, MSFT is making moves to improve in that area with the acquisition of Nokia's devices business and a new Surface tablet. So we have a somewhat mixed picture, some lines growing quickly and some lines stagnant.
Using Yahoo finance we see the current P/E for MSFT is 12 and the PEG rate is 1.43. We also see MSFT has cash of over $9.00 per share on its balance sheet and has healthy profit margins of 28.8% and operating margins of 23.38%. Those economic indicators are very good.
Most importantly, earnings for the last 5-years have grown at a rate of 11.5% and are forecast to grow the next 5-years at 8.6%
In summary, we have a company with a rock solid balance sheet, nice margins, over $9.00 a share cash, a low P/E of 12 that is growing earnings 8% a year. I believe that is a compelling opportunity.
Lesson 5 - The importance of the dividend. In this category MSFT scores high points. Using David Fish's excellent DRIP Investing Resource Center we see MSFT is a Dividend Contender having raised its dividend 11 straight years and is currently yielding 3.3%. It recently raised its dividend 22.1% and has raised the dividend an average of 15.1% over the last 5 years. With a payout ratio of approximately 34% and with strong cash flow, MSFT will be able to raise its dividend for years to come.
Summary - The truth is, none of us can be like Warren Buffett. We all are unique individuals with various skills, talents and weaknesses. Warren Buffett has a unique DNA that allows him to see, understand, and value investing opportunities better than the rest of us. What we can do, is see the investing traits and habits that he has and try to emulate them. Those habits and traits have proved effective over time.
No matter what you want to learn, it is always best to learn from those that have had great success. In investing, Warren Buffett has had unequaled success. The wise investor will take the habits and traits Warren Buffett has and incorporate them into their own investing plan.
Additional disclosure: I may initiate a position on MSFT in the 72 hours.