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I am an author of books related to the decision framing and optimizing processes of Buffett and Munger. These books are available at and: With integrity and patience, we can also earn superior profits by carefully evaluating facts and... More
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The Four Filters Invention of Warren Buffett and Charlie Munger
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  • Introduction To The Second Edition Of The Four Filters Invention Of Warren Buffett & Charlie Munger

    Having read the first edition 5 years ago, Charlie Munger (Trades, Portfolio) recently wrote: "I applaud your effort and many of your conclusions."

    How do we improve and optimize our investing decision making? This was the goal of the first edition of this book. Now, about 5 years later, this journey continues with more insights and examples.

    We can use the Four Filters Invention of Warren E. Buffett and Charles T. Munger. Their four filters investing process helps us eliminate many inferior investing prospects. This filtering process helps us find high-quality winning investments. Their steps include evaluating a business' economics, its competitive position, its managers, and its intrinsic value. It provides us a tested and effective toolset.

    How and why are these filters effective? Warren Buffett (Trades, Portfolio) said it best: "An investor cannot obtain superior profits from stocks by simply committing to a specific investment category or style. He or she can earn them only by carefully evaluating facts and continuously exercising discipline." These four filters focus on the business facts about the Products, Customers, Management, and the Financial Safety given by a bargain purchase.

    The Four Filters are a search for: "Understandable first-class businesses, with enduring competitive advantages, accompanied by first-class managements, available at a bargain price."[i]

    In my view, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) invented an investing formula that is underappreciated by the business and academic communities. It is an amazing intellectual achievement in both practical and Behavioral Finance. The filters are an important set of steps used by the world's greatest investors for finding high quality investments.

    As a useful guide for assessing intrinsic value and sensible price, the filters function as an effective time-tested focusing process for investing success. They help us frame our investing decision making process correctly, and help us prevent foolish and costly losses. Using this process, you and I will become better investors. We improve the way we think about businesses. This innovation uses qualitative factors as well as quantitative factors to help us find and insure a good stock or whole business for investment. It raises the odds of investing success.

    The first edition received some criticism from casual readers stating that it restated many of the writings and talks of Buffett and Munger. Yes, it did. I tried to tell the story from their perspective. So the use of many quotations was necessary, and they were approved for use.

    These critical readers did not realize that I was trying to design a book as if Warren or Charlie had written it themselves. Perhaps, I did not explain that clearly enough.

    For example, if I insert a passage like this next one by Charlie Munger (Trades, Portfolio), it illustrates his frame of mind: "The way to win is to work, work, work, work and hope to have a few insights…. And you're probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It's just that simple."[ii]

    This book is about the intellectual collaboration and experiences of two good friends who smartly changed the world of investing and invented a thoughtful and effective process. They made a lot of money for themselves and their shareholders. There is another treasure hidden in these words: how to improve and optimize our decision making process.

    This is also a story about exercising self-discipline. Look to the future and think clearly for yourself. Be open to new ideas from wise people. Study the past, and learn from it. As Ben Graham said in the introduction of his book, The Intelligent Investor: "No statement is more true and better applicable to Wall Street than the famous warning of Santayana: "Those who do not remember the past are condemned to repeat it."

    History is important to Charlie Munger (Trades, Portfolio) as well. He said this: "Business schools fail by teaching what is easy to teach but less useful. Going back to teaching business history as Harvard used to would be good; there's a lot to be learned from the rise and fall of GM, or the rise and fall and rise of railroads."

    This book is about one smart way to frame a decision process using sound principles. How do we develop a better understanding of a business, its products, its present, its management, its earnings, and its future? Charlie Munger (Trades, Portfolio) said, "We read a lot. I don't know anyone who's wise who doesn't read a lot. But that's not enough: You have to have a temperament to grab ideas and do sensible things."[iii]

    This year, 2014, I learned something new from the 2013 annual letter. I learned that retained earnings can be a "powerful competitive advantage." Warren Buffett (Trades, Portfolio) put it this way: "Here's a little known fact: Last year MidAmerican retained more dollars of earnings - by far - than any other American electric utility. We and our regulators see this as an important advantage - one almost certain to exist five, ten and twenty years from now."

    Over the years, I have read all of the Letters to Shareholders of Berkshire Hathaway. I have also read most of the books and articles about Warren Buffett (Trades, Portfolio), his teacher Benjamin Graham, and his business partner Charlie Munger (Trades, Portfolio). I also served as the editor of Scott Thompson's fine textbook: "The Art & Science of Value Investing."

    Having listened to many hours of audio lectures and interviews, I have been consistently interested in how Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) "frame" an investment decision, and how they find a winning investment prospect. This book is a story about their rational filter process. It helps them make better investing decisions. In the words of Charlie Munger (Trades, Portfolio), "You have to understand the odds and have the discipline to bet only when the odds are in your favor."[iv] And, I hope that this second edition adds more meat (examples) into your decision making process.

    Warren Buffett (Trades, Portfolio) has written about the Four Filters in several ways. This behavioral sequence is always similar: "Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag."[v] While Charlie Munger (Trades, Portfolio) has described the process as getting into high quality businesses, Warren Buffett (Trades, Portfolio) has also phrased the Four Filter process in this slightly different way: "When buying companies or common stocks, we look for understandable first-class businesses, with enduring competitive advantages, accompanied by first-class managements, available at a bargain price."[vi]

    In 1996, Buffett wrote this about investing in public companies. It is a twist on the Four Filter formula that sets the bar towards realism and conservativism: "The art of investing in public companies successfully is little different from the art of successfully acquiring subsidiaries. In each case you simply want to acquire, at a sensible price, a business with excellent economics and able, honest management. Thereafter, you need only monitor whether these qualities are being preserved."[vii]

    After devoting hours of thinking time into their investing ideas and guiding principles[viii], I felt like a man who stumbled upon hidden treasure in the middle of his back yard. I rediscovered a simple sequence called the Four Filters! They were there all the time.

    In the 2003 Berkshire Hathaway annual meeting, a man asked Warren Buffett (Trades, Portfolio) this question: "Could you just take us thru your filter process when it comes to, selecting a company?" Warren Buffett (Trades, Portfolio) answered, "It's a question of a. Can I understand it?...if it makes it thru that filter…b. Does it have some kind of sustainable long-term competitive advantage…" If it makes it thru that filter…How do I feel about the management in terms of, their ability and honesty?.. and if it makes it thru that filter,…What's the price?... And if it gets it thru all four filters, I sign my name to the check."

    These ideas sound so simple. Many people hear them at the Berkshire Hathaway annual meeting in Omaha each year. Yet, few people have stopped to think about the importance and usefulness of each individual filter.

    As a formula, the Four Filters function as a set of "Investing Best Practices." They help us develop better "self-control." They force us to focus on "Wonderful Businesses."[ix] They function as a smart targeting system steering us with clear goals. And, using the Four Filters, promotes investing "self-discipline." This book unveils how the Four Filters are a significant intellectual achievement in Behavioral Finance.

    In addition to the framing aspects to this decision making, the checklist nature of these Four Filters serve as a logical and sensible justification mechanism. A standard checklist serves to confirm or disconfirm evidence. Like pilots who use checklist prior to flying, the Four Filters help us frame a rational investment decision. Charlie Munger (Trades, Portfolio) believes in using checklist routines to help us avoid a lot of errors. These errors occur because our human brains are wired to find shortcuts, or what Munger calls "shortcut types of approximations."

    Charlie Munger (Trades, Portfolio) said: "The main antidotes to miscues from Availability-Misweighing Tendency often involve procedures, including the use of checklists, which are almost always helpful."[x] At the USC Law School Commencement speech in 2007, he said: "You should have all of this elementary wisdom, and you should go through a mental checklist in order to use it. There is no other procedure that will work as well."[xi] Munger has also said: "You need a different checklist and different mental models for different companies. I can never make it easy by saying, 'Here are three things.' You have to derive it yourself to ingrain it in your head for the rest of your life."

    To be fair, other great investors used quality checklists to earn profits. And, other great investors contributed "Best Practices" to the art of effective investing. Later in this book, we see the contributions of several investing thought leaders.

    Do you have a "Happy Zone?" The Four Filters serve to increase the probability of investment success by defining "the right ball to hit." Buffett tells students this Ted Williams baseball analogy: "I put heavy weight on certainty. Use probability in your favor and avoid risk. It's not risky to buy securities at a fraction of what they are worth. Don't gamble. You're dealing with a lot of silly people in the marketplace; it's like a great big casino, and everyone else is boozing. Watch for unusual circumstances. Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. In appraising the odds, Ted Williams explained how he increased his probability of hitting: "My argument is, to be a good hitter, you've got to get a good ball to hit. It's the first rule in the book."

    This book trims "all the lean beef" into five chapters: "the Four Filter chapters and a summarizing chapter." The final summary chapter ties the filters together and demonstrate why these filters work to maximize the probability of investing success from both a mathematical and a practical point of view. This second edition adds in more solid examples as well as insights I have learned in the past five years. See the new section on Coca-Cola and their "Yield On Cost" estimation.

    So, how were these Four Filters developed? Over the course of their investing experiences, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) have had many discussions about the qualities of bad, good, and mediocre businesses they had invested in. Also, keep in mind that Charlie Munger (Trades, Portfolio) believes wisdom acquisition is a moral duty.[xii] So, the Four Filters seem to have evolved from their discussions and their early business and investing experiences.

    Interestingly, the 1977 Letter to Shareholders of Berkshire Hathaway is the earliest one listing the Four Filters. It is also the earliest letter posted at the company's website: ( ). This Four Filters Formula was presented in this form: "We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price."[xiii]

    Charlie Munger (Trades, Portfolio) said that once they had gotten over the hurdle of recognizing that a business could be a bargain based on quantitative measures that would have horrified Ben Graham, they started thinking about better businesses. Their results show the bulk of the billions earned at Berkshire Hathaway have come from the better businesses. Munger described their system this way: "We came to this notion of finding a mispriced bet and loading up when we were very confident that we were right. So we're way less diversified. And I think our system is miles better."[xiv]

    For years, Buffett and Munger would site See's Candies as the best example of a "wonderful business." See's Candies taught Buffett and Munger much about the evaluation of franchises. Both men admit that they have made significant money because of the lessons they learned at See's. See's Candies is the wonderful business.

    In their talks and writings, they refer to a great business as a "franchise" or a "wonderful business." Buffett wrote: "An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mismanagement. Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage."

    Buffett and Munger respect able and trustworthy managers. As you read about these great businesses, think about the product or service that: (1) is strongly desired; (2) has no close substitute and; (3) has pricing power. As Buffett said, "A moat that must be continuously rebuilt will eventually be no moat at all. Additionally, this criterion eliminates the business whose success depends on having a great manager." He summarizes it this way: "We believe that our formula - the purchase at sensible prices of businesses that have good underlying economics and are run by honest and able people - is certain to produce reasonable success. We expect, therefore, to keep on doing well."

    [i] The Four Filters, Berkshire Chairman's Letter to Shareholders, 2007.

    [ii] From the talk called "A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business" by Charles Munger, USC Business School, 1994.

    [iii] Berkshire Hathaway Annual Meeting, 2004.

    [iv] Charlie Munger (Trades, Portfolio) talk at Harvard Law School, 2001.

    [v] Berkshire Chairman's Letter to Shareholders, 2007, 6.

    [vi] Berkshire Chairman's Letter to Shareholders, 1989,(

    [vii] Berkshire Chairman's Letter to Shareholders, 1996.

    [viii] Owner-oriented principles, Berkshire Hathaway Owner's Manual, 1996.

    [ix] Berkshire Chairman's Letter to Shareholders, 1989,(

    [x] (The Psychology of Human Misjudgment Revised Speech by Charles T. Munger), Kaufman, Peter D., Poor Charlie's Almanack, Virginia Beach, VA: PCA Publication, LLC, 2005.

    [xi] Charlie Munger (Trades, Portfolio)'s speech at USC Law School Commencement, 2007.

    [xii] Charlie Munger (Trades, Portfolio)'s speech at USC Law School Commencement, 2007.

    [xiii] Berkshire Chairman's Letter to Shareholders, 1989, (

    [xiv] A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business". Charles Munger, USC Business School, 1994.

    Disclosure: I am long BRK.A, BRK.B.

    Additional disclosure: I am the author of several books related to investment decision framing that are related to Warren Buffett, Charlie Munger, and Berkshire Hathaway.

    Mar 23 7:35 PM | Link | Comment!
  • The Second Edition Of Four Filters Invention Of Buffett & Munger Is Now Available.

    The SECOND EDITION has more examples and insights !

    It has grown from 146 to 206 pages. This edition has more Berkshire business examples added into the four core chapters. I took some of the examples from my book MOATS and edited in key businesses. Then, I explained how each is tied into the four main themes. Along the way, I tried to add in bits of how my thinking about these areas has evolved in the past five years. For example, five years ago, I did not realize the "competitive potency" of retained earnings in building up a business' moat. And, businesses having 40% gross margins, 30% operating margins, and 20% net margins, may have sustainable competitive advantages.

    (click to enlarge)

    "The Four Filters Invention of Warren Buffett and Charlie Munger" examines each of the steps they perform in framing and making an investment decision. The author believes that Buffett and Munger expanded the field of "Behavioral Finance" by using this thoughtful and effective process. The genius of Buffett and Munger's four filters process was to capture all the important stakeholders in their decision making. Imagine... Products, Enduring Customers, Managers, and Margin-of-Safety... all in one mixed "qual + quant" formula.

    This second edition contains additional examples in this amazing process. This edition also contains the author's look into their 1988 valuation of Coca-Cola. Each chapter has additional specific examples. The author also discusses additional insights he has learned in the past five years since the first edition was released.

    Disclosure: I am long BRK.A, BRK.B.

    Additional disclosure: I am the author of several books on decision framing in value investing related to Buffett, Munger, and Berkshire Hathaway businesses.

    Mar 18 9:25 AM | Link | Comment!
  • Winners Of The Great Recession

    Winners Of The Great Recession

    By Bud Labitan

    Over the past five years, these businesses have prospered mightily. They have produced excellent returns in generating free cash flow for shareholders.

    Apple Inc. AAPL

    Google, Inc. GOOG

    CF Industries CF PCLN

    BlackRock, Inc. BLK

    ExxonMobil XOM

    How did these businesses manage to prosper in a time many consider to be the worst economic period since the great depression of the 1930's? First, let me place this disclaimer. Some of these business descriptions are taken directly from each company's marketing material as well as other online sources.

    The Great Global Recession of 2009 began around December 2007 and it took a sharper dive in September 2008. Recall that U.S. housing bubble peaked in 2006. But, irrational bubble valuation forces caused the values of securities tied to U.S. real estate pricing to plummet and damage financial institutions globally. It was sparked by the outbreak of the U.S. subprime mortgage crisis and financial crisis of 2007-08. The exact start and end-point for the recession greatly varied from country to country. Overall, it was the worst global recession since World War II.

    Let's review how these businesses prospered during this Great Global Recession.

    First, Apple designs, manufactures, and markets personal computers, mobile communication devices, and portable digital music and video players. It sells a variety of related software, services, peripherals, and networking solutions. It's products and services include iPhone®, iPad®, Mac®, iPod®, Apple TV®, a portfolio of consumer and professional software applications, the iOS and OS X® operating systems, iCloud®, and a variety of accessory, service and support offerings. Apple sells its products through its online stores, retail stores, direct sales force, and third-party wholesalers, resellers, and value-added resellers.

    Apple also sells and delivers digital content and applications through the iTunes Store®, App StoreSM, iBookstoreSM, and Mac App Store. In addition, the Company sells a variety of third-party iPhone, iPad, Mac and iPod compatible products, including application software, and various accessories, through its online and retail stores. Its reportable operating segments consist of the Americas, Europe, Japan, Asia-Pacific and Retail. The Europe segment includes European countries, as well as the Middle East and Africa. The Asia-Pacific segment includes Australia and Asian countries. Apple's success has been in creating appealing devices that attract loyal customers who are willing to pay premium prices to own this brand.

    Next, Google Incorporated became the most popular internet search service. This global technology company is engaged in improving the ways people connect with information. It is now focused around the key areas of: search, advertising, operating systems and platforms, enterprise and hardware products. It integrates innovative features into its search service and offer specialized search services to help users tailor their search.

    In January 2012, the Company launched Search plus Your World. When a user performs a signed-in search on Google, the user's results page may include Google+ content from people that the user is close to. Advertising includes Google Search, Google Display, Google Mobile and Google Local. AdWords is the Company's auction-based advertising program delivering ads relevant to search queries or Web content.

    The Company, along with Open Handset Alliance has developed Android mobile software platform that any developer can use to create applications for mobile devices and any handset manufacturer can install on a device.

    Google Chrome OS is an open source operating system with the Google Chrome Web browser as its foundation. The Chrome browser runs on Windows, Mac, and Linux computers. Google TV is a platform that enables the consumers to experience television and the Internet on a single screen, with the ability to search and find the content they want to watch. It is based on the Android operating system and runs the Google Chrome browser.

    Google's enterprise products provide Google Apps. These include Gmail, Google Docs, Google Calendar, and Google Sites. The Company provides hosted, Web-based applications that people use on any device with a browser and an Internet connection.

    The Company also provides versions of its Google Maps Application Programming Interface (NYSEMKT:API) for businesses, as well as Google Earth Enterprise (a behind-the-company-firewall software solution for imagery and data visualization).

    Google competes with Yahoo! Inc., Microsoft Corporation's Bing, YouTube, Facebook, Twitter, WebMD for health queries, Kayak for travel queries, for job queries, and and eBay for e-commerce.

    Google's success has been in creating an appealing and useful search service and the Android operating system that attract customers.

    This business was a bit of a surprise to me. I did not realize how much the fertilizer industry has grown until I viewed an insightful PBS documentary called "America Revealed."

    With only 2,600 employees, CF Industries Holdings, founded in 1946, manufactures and distributes nitrogen and phosphate fertilizer products around the world. The business of the Company is divided into two operating segments, the nitrogen segment and the phosphate segment. The Nitrogen segment includes the manufacture and sale of ammonia, urea, and UAN. The Company's principal products in the nitrogen segment are ammonia, granular urea, urea ammonium nitrate solution, or UAN, and ammonium nitrate, or AN. The Company's other nitrogen products include urea liquor, diesel exhaust fluid, or DEF, and aqua ammonia, which are sold primarily to its industrial customers. The Company operates seven nitrogen fertilizer production facilities in North America.

    The phosphate segment includes the manufacture and sale of DAP and MAP. The Company's principal products in the phosphate segment are diammonium phosphate, or DAP, and monoammonium phosphate, or MAP. The Company's core market and distribution facilities are concentrated in the Midwestern United States and other major agricultural areas of the U.S. and Canada.

    CF Industries Holdings also exports nitrogen fertilizer products from its Donaldsonville, Louisiana manufacturing facilities and phosphate fertilizer products from its Florida phosphate operations through its Tampa port facility. In the nitrogen segment, the Company's primary North American-based competitors include Agrium and Koch Nitrogen Fertilizers. In the phosphate segment, the Company's primary North American-based competitors include Agrium, Mosaic, Potash Corp. and Simplot.

    CF Industries' success has been in creating a large and efficient producer and distributor of nitrogen and phosphate based fertilizers around the world.

    Next, is Incorporated. It shows us that customers took their bargain hunting practices online and found Priceline appealing. is an online travel company that offers its customers a range of travel services, including hotel rooms, car rentals, airline tickets, vacation packages, cruises and destination services.

    Priceline also operates a retail, price-disclosed hotel reservation service in the United States, which enables its customers to select the exact hotel they want to book. Then, the price of the reservation is disclosed prior to booking. It offers such reservations through a merchant model, as well as through an agency model for hotel room night reservations sourced through is the internet hotel reservation service, with offices worldwide. works with over 185,000 hotels and accommodations in over 160 countries offering hotel reservations on various websites and in 41 languages. In May 2010, it acquired the business, a United Kingdom-based international rental car reservation service formerly known as TravelJigsaw. offers its car hire services in more than 4,000 locations throughout the world, with customer support provided in 38 languages.

    Priceline competes with both online and traditional sellers of the services it offers. The market for the services it offers is intensely competitive, and current and new competitors can launch new sites at a relatively low cost. However, over the past five years, customers found Priceline to be the appealing leader in this space.

    Next, Blackrock Incorporated made my list because it showed tremendous growth and profitability during this period. BlackRock, Inc. is the publicly traded investment management firm. BlackRock along with its subsidiaries provides investment management and securities lending services to institutional clients and to individual investors through various investment vehicles. Investment management services mainly consist of the management of fixed income, cash management and equity client accounts, the management of a number of open-end and closed-end mutual fund families, exchange traded funds and other non-U.S. equivalent retail products serving the institutional and retail markets, and the management of other investments funds, including common trusts and alternative funds, developed to serve various customer needs.

    BlackRock also provides market risk management, financial markets advisory and enterprise investment system services to a base of clients. Financial markets advisory services include valuation services relating to illiquid securities, dispositions and workout assignments, risk management and strategic planning and execution.

    BlackRock's clients include taxable, tax-exempt and official institutions, high net worth individuals and retail investors. On December 1, 2009, BlackRock acquired Barclays Global Investors ("BGI") from Barclays Bank PLC ("Barclays"), referred to as the "BGI Transaction", adding investment and risk management capabilities and more than 3,500 new colleagues to the combined organization.

    BlackRock's BGI Products include equity, Fixed income, Multi-Asset Class, Alternative Investments, Alternative Investments, Cash Management, BlackRock Solutions and Advisory, Transition Management Services and Product Performance Notes. BGI has long been recognized for product innovation in indexed and scientific investing, including pioneering iShares, the industry's ETF platform, sophisticated retirement solutions and liability-driven investment strategies. These strengths complement BlackRock's active fundamental portfolio management capabilities, global mutual fund platform, customized solutions, risk management and advisory services.

    BlackRock operates in a global marketplace characterized by a high degree of market volatility and economic uncertainty, factors that can significantly affect earnings and stockholder returns in any given period. The Company's product offerings, which enhance its ability to offer a variety of traditional and alternative investment products across the risk spectrum and to tailor single- and multi- asset class investment solutions to address specific client needs. In addition, through BlackRock Solutions, the Company offers a broad spectrum of investment management and risk management products and services.

    Investment management offerings include single- and multi-asset class portfolios, which might be structured to focus on a particular investment style, capitalization range, region or market sector; credit or maturity profile; or liability structure. It uses Aladdin and other state-of-the-art tools and work closely with BlackRock's trading cost research team to manage four dimensions of risk throughout the transition: exposure, execution, process and operational risk.

    BlackRock manages money for institutional and retail investors worldwide. Its client base is by both geography and client type. The Company serves clients through 74 offices across four regions: United States and Canada, EMEA, Asia Pacific and Latin America and Iberia.

    BlackRock clients include tax-exempt institutions, such as defined benefit and defined contribution pension plans, charities, foundations and endowments; official institutions, such as central banks, sovereign wealth funds, supranationals and other government entities; taxable institutions, including insurance companies, financial institutions, corporations and third party fund sponsors; and retail and high net worth investors. Since customers found Blackrock managers to be able and trustworthy, it grew and profited mightily during this period.

    Finally, I mention the giant energy company ExxonMobil. I read that Berkshire Hathaway's portfolio has recently shown a new position of 40.1 million shares valued at $3.4 billion.

    ExxonMobil (NYSE: XOM) is the largest of the vertically integrated oil companies. It is also the second largest publicly-traded corporation in the world by market cap and revenue. With a market value of $417 billion, and smart strategic investments, ExxonMobil has longevity. It also pays a 2.7% dividend yield.

    In his 2011 shareholder letter, Buffett wrote: "A century from now... ExxonMobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions..."

    Recent investments in shale and natural gas production indicate that ExxonMobil will be earning cash for its shareholders for the next several decades. It has invested more in natural gas. ExxonMobil completed a $30 billion project to develop the world's largest natural gas field. This field is located in the Persian Gulf state of Qatar. It is expected to boost the company's gas production and make ExxonMobil the world's largest natural gas producer. The North Field is expected to contain 900 trillion feet of natural gas. ExxonMobil also agreed to a joint venture with Royal Dutch Shell and Chevron to construct a liquefied natural gas facility on Barrow Island off the coast of Australia. Chevron will own 50% of the facility while Shell and Exxon will each have 25%.

    Exxon strengthened itself in Natural Gas by the acquisition of XTO Energy (shale). XTO has a strong hold in shale, including the Marcellus, Haynesville and the Bakken basins.

    XTO drove a surge in U.S. fuel output by exploiting fracking. XTO Energy's resource was reported to consist of 45 trillion cubic feet of gas. The XTO acquisition complimented Exxon's presence in other shale areas such as the Piceance Basin in Colorado. The company has been producing natural gas from the basin for more than 50 years and it has a reported estimate of 1.5 trillion barrels of in-place oil shale resources.

    So, what about an estimate of ExxonMobil's stock value? Here, I propose that ExxonMobil has created a sustainable competitive advantage that I did not appreciate prior to reading about Buffett and Berkshire's recent investment. Its moves to secure future sources of oil, shale, and natural gas has secured more years of future cash flows for its shareholders.

    If we do a simple one or two stage DCF valuation estimation based on 10 to 15 years, a big piece of value may be missed. I argue that ExxonMobil has created a valuable advantage for itself and its shareholders that stretch the Excess Return Period (yrs) to at least 20 years, and maybe even more years. So, here is my argument simplified. For the sake of simplicity and estimation, let's first take a look at the DCF estimate posted at Is it reasonable? Did Buffett and Berkshire get a good bargain?

    Here is one view to consider. For the sake of conservatism, we may drop the growth rate to 5% at their model. However, I argue that, in view of long rage planning and investments in shale and natural gas, you may also conservatively extend the Excess Return Period (yrs) to 20 years. This would result in an estimated intrinsic value of about $135 per share. And, if Buffett and Berkshire purchased XOM at an average cost of $85, they got a bargain of around 37% in a large business leader. Over time, the world economies will demand more energy production. In consideration of ExxonMobil's added durable competitive advantages, the "Yield On Cost" of this investment may prove to be even more profitable.

    In summary, how do we tie all these good stories together? Think of the times when customers are pleased by the terms of supply and demand. As Ben Franklin wisely said, "No nation was ever ruined by trade."

    * * * *

    Bud Labitan is the author and editor of "MOATS : The Competitive Advantages of Buffett & Munger Businesses." Moats discusses the competitive advantages of 70 Berkshire Hathaway businesses and it is targeted towards business school students, investors, and business managers. He is also the author of other books on investment decision framing and decision making. These include the "1988 Valuation of Coca-Cola", "Price To Value", "Valuations", and "The Four Filters Invention of Warren Buffett and Charlie Munger."

    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL, GOOG, CF, PCLN, BLK, XOM, BRK.A over the next 72 hours.

    Nov 22 9:05 PM | Link | Comment!
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