“How do you beat world chess champion Bobby Fischer? Yes, it is a bit of a trick question. If you want to beat Bobby Fischer, you don’t play chess with him. You find a game that you can win.” – Buffett Beyond Value by Prem Jain
“If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.” – The Art of Stock Picking by Charlie Munger
In a crowded field full of books dedicated to learning and profiting from the lessons taught by Warren Buffett, Georgetown University Professor Prem C. Jain’s Buffett Beyond Value has made an important and timely contribution. Warren Buffett’s investment style has never neatly fit into a “value” or “growth” box and while many have attempted to emulate his style, very few have built track records that are in any way comparable. Part of the reason is a fundamental failure to understand Warren Buffett’s true investment approach.
Not a Biography – Just the Investment Principles, Please …
Most value investors find Warren Buffett’s personal history fascinating for many reasons. Some of us can identify with Mr. Buffett’s early years of throwing newspapers and saving as much money as possible. Others may identify with other aspects of his life story such as the personal problems he experienced as he approached middle age. There are already two excellent biographies covering Mr. Buffett’s life story and Prof. Jain had no intention of creating a third. Instead, he clearly states that he only wishes to cover Mr. Buffett’s investment philosophy rather than his entire life.
In fact, neither of the major Buffett biographies does an adequate job of identifying the key drivers of Mr. Buffett’s investment performance over the years. It is likely that their authors never intended to do so. Prof. Jain succeeds in identifying the key drivers that are responsible for Mr. Buffett’s success. Some elements of Mr. Buffett’s psychological makeup that probably led him to adopt his investment principles are not covered but it is debatable whether we really need that level of understanding if our only interest involves learning from Mr. Buffett’s investing success.
Buffett: The Renaissance Investor
Rather than characterizing Mr. Buffett as a “value investor” or a “growth investor”, Prof. Jain correctly observes that his investment style is a well refined mix of both disciplines. Mr. Buffett clearly started out as a deep value investor and was heavily influenced by his mentor Benjamin Graham. Managing small amounts of money in the 1950s and early 1960s, Mr. Buffett was able to achieve spectacular results by focusing on “cigar butts” that had a free puff left. Much can still be learned from Ben Graham as we discuss in a recent review of Security Analysis.
Over time, size and the influence of business associates led Mr. Buffett to see the virtue of buying high quality companies. In our essay From Cigar Butts to Business Supermodels, we mark the transition away from deep value with the acquisition of See’s Candies. Prof. Jain focuses more on Mr. Buffett’s move into insurance and the trading stamp “float” acquired with Blue Chip Stamps. However, the underlying trend is the same: Mr. Buffett’s move toward quality drove much of Berkshire’s success over the past four decades. Charlie Munger deserves the bulk of the credit along with others such as Philip Fisher, the author of Common Stocks and Uncommon Profits.
Good Introduction to Berkshire
Prof. Jain succeeds in providing the reader with a high level survey of Berkshire Hathaway (NYSE:BRK.A). Those of us who have followed the company for many years or decades can forget that the company can be very complex for someone who is just starting to learn about it. In a concise set of chapters, Prof. Jain walks the reader through Berkshire’s most important subsidiaries. In particular, his treatment of Berkshire’s insurance subsidiaries and the basics of property/casualty insurance will help many who are new to Berkshire. This makes the book a perfect introduction to Berkshire for family, friends, or clients.
While the book cannot be considered a comprehensive guide to accounting or the process required to fully analyze investments, Prof. Jain does present the reader with many useful techniques to identify “good” businesses offering high returns on invested capital as well as warning signs to avoid poor businesses that probably do not meet the criteria of an intelligent investment except perhaps at distressed prices. The section on profitability and accounting is an appropriate introduction for readers less familiar with the topics covered, particularly in the treatment of goodwill.
Prof. Jain also recognizes the importance of psychology and presents two useful chapters on the subject. One of the most useful pieces of advice is very basic but almost universally ignored: investors should keep a diary or a log of all investment decisions and evaluate themselves against their original criteria. If all investors forced themselves to do this as well as to run through basic checklists, the odds of making poor decisions would decrease substantially. This concept actually has nothing to do with investing and can be applied to any life decision.
Staying Within a Circle of Competence
The two quotes presented at the beginning of this article are obvious yet rarely followed by investors. Warren Buffett avoids straying from his circle of competence and, as a result, makes few errors over long periods of time. But does Mr. Buffett’s aversion to technology stocks indicate that all value investors must avoid technology stocks? The answer is no. Mr. Buffett avoids technology because it falls outside his circle of competence. Others may avoid insurance if it is outside their circle of competence. Prof. Jain has made a significant contribution to the crowded field of books on Warren Buffett by illustrating how Mr. Buffett’s success is driven from a consistent attempt over many decades to blend value and growth strategies while insisting on participating only in situations that he clearly understands.
Disclosure: Ravi Nagarajan received a complimentary review copy of Buffett Beyond Value from Prem Jain. Ravi Nagarajan also owns shares of Berkshire Hathaway.