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1995: Does Buffett still use Graham's formula from The Intelligent Investor?
AUDIENCE MEMBER: John Rankin (PH), Fort Collins, Colorado. Thanks for having us.
In the book, “Warren Buffett Way,” the author describes the capital growth model that you’ve used to evaluate intrinsic value in common stock purchases.
My question is, do you also still use the formula Ben Graham described in “The Intelligent Investor,” that uses evaluating anticipated growth, but also book value?
It seems to me that fair value is always a bit higher when using Mr. Graham’s formula than the stream of cash discounted back to present value that is in “Warren Buffett Way” and also that you’ve alluded to in annual reports.
WARREN BUFFETT: Yeah, we’ve tried to put in the annual report pretty much how we approach securities. And book value is not a consideration — virtually, not a consideration at all.
And the best businesses, by definition, are going to be businesses that earn very high returns on capital employed over time. So, by nature, if we want to own good businesses, we’re going to own things that have relatively little capital employed compared to our purchase price.
That would not have been Ben Graham’s approach. But Ben Graham was — Ben was not working with very large sums of money. And he would not have argued with this approach, he just would’ve said his was easier. And it is easier, perhaps, when you’re working with small amounts of money.
My friend Walter Schloss has hewed much more toward the kind of securities that Ben would’ve selected. But he’s worked with smaller amounts of money. He has an absolutely sensational record. And it’s not surprising to me at all. I mean, when Walter left Graham-Newman, I would’ve expected him to do well.
But I don’t look at the primary message, from our standpoint, of Graham, really, as being in that — in anything to do with formulas. In other words, there’s three important aspects to it.
You know, one is your attitude toward the stock market. That’s covered in chapter eight of “The Intelligent Investor.” I mean, if you’ve got that attitude toward the market, you start ahead of 99 percent of all people who are operating in the market. So, you have an enormous advantage.
Second principle is the margin of safety, which again, gives you an enormous edge, and actually has applicability far beyond just the investment world.
And then the third is just looking at stocks as businesses, which gives you an entirely different view than most people that are in the market.
And with those three sort of philosophical benchmarks, the exact — the evaluation technique you use is not really that important. Because you’re not going to go way off the track, whether you use Walter’s approach — Walter Schloss’s — or mine, or whatever.
Phil Carret has a slightly different approach. But it’s got those three cornerstones to it, I will guarantee. And believe me, he’s done very well.
CHARLIE MUNGER: Yeah. To the extent that the method of estimating future cash flow requires projections, I would say that projections, while they’re logically required by the circumstances, on average, do more harm than good in America.
Most of them are put together by people who have an interest in a particular outcome. And the subconscious bias that goes into the process, and its apparent precision, make it — makes it some — well, it’s fatuous, or dishonorable, or foolish, or what have you.
Mark Twain used to say a mine is a hole in the ground owned by a liar. And a projection prepared in America by anybody with a commission, or an executive trying to justify a particular course of action, will frequently be a lie.
It’s not a deliberate lie, in most cases. The man has gotten to believe it himself. And that’s the worst kind.
So, I don’t think we should — projections are to be handled with great care, particular when somebody has an interest in misleading you.
WARREN BUFFETT: Charlie and I, I think it’s fair to say, we’ve never looked at a projection in connection with either a security we’ve bought or a business we’ve bought. We’ve had them offered to us in great quantities.
Now, the fact that we voluntarily turn them away when people try to thrust them upon us — I mean, it — the very fact that they are prepared so meticulously by the people who are selling the businesses, or by the executives who are presenting to their boards and all of that sort of thing, you know, I mean, either we’re wrong or they’re wrong.
It’s a ritual that managers go through to justify doing what they wanted to do in the first place, in about nine cases out of ten.
I have never, you know, I have never met an executive who wanted to buy something that said, “Well, I had to turn it down because the projections didn’t work.” I mean, it’s just — it’s never happened.
And there will always be somebody that will come up with the projections that will satisfy the guy who’s signing his paycheck or will sign the deal that provides the commissions.
And they will pass those along to whomever else they need, the bankers or the board, to approve it.
It is total nonsense. I was recently involved in some — in a situation where projections were a part of the presentation. And I asked that the record of the people who made the projections, their past projections also be presented at the same time. (Laughter)
It was a very rude act. (Laughter)
CHARLIE MUNGER: It was regarded as apostasy.
WARREN BUFFETT: It — but believe me, it proved the point. I mean, it was a joke, I mean. So, we’ll leave it at that.