Lessons from Warren Buffett’s 40-Year-Old Ad
In 1983, Warren Buffett sat down to pen his annual letter to Berkshire Hathaway shareholders. Tucked away at the back of the letter was an ad. Specifically, it was a “business wanted” ad. In it, the Oracle of Omaha outlined the type of businesses he and his partner Charlie Munger were seeking to acquire.
The ad listed six characteristics they preferred when looking at a business. The checklist is simple to understand and chock full of wisdom. The concepts will help any investor achieve gains over time – and keep them out of trouble!
Here’s the list:
- Large earnings (at least $5 million of after-tax earnings);
- Demonstrated consistent earnings power (future projections are of little interest to us, nor are “turn-around” situations);
- Businesses earning good returns on equity while employing little or no debt;
- Management in place (we can’t supply it);
- Simple businesses (if there’s lots of technology, we won’t understand it); and
- An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).
Some of these are self-explanatory, but there is a lot implied behind each one.
Large earnings
You can be sure that if this ad was running today, Buffett would raise the earnings bar. And that’s the point to take away here. Size can be a hindrance. As Berkshire Hathaway ballooned in size, Buffett had to transition from good ideas to good big ideas, and there are far fewer of the latter. Most of us don’t have these restraints and can invest in smaller companies – the type that are off Wall Street’s radar and can have years of exponential growth ahead of them.
Consistent earnings power
Last year, 2022, was tough for stock investors. But it was particularly punishing for investors who believed in “hockey stick” projections – the kind that show currently unprofitable companies quickly flipping to spectacular earnings in the years ahead. Some of them will. Many won’t. If you don’t have special insight and strong conviction behind these companies, steer clear and invest in those with proven results. Sure, a strong operational track record doesn’t guarantee repeat performance. But it certainly increases the odds that you’ve found a company worth investing in.
Good returns with little or no debt
Leverage is powerful. A lot of debt can amplify company returns when business is good. It can do the opposite during a slowdown. And if that debt burden is heavy enough, a business that might otherwise be resilient could instead be forced into bankruptcy by a minor misstep. That’s no way to compound wealth over time. This lesson is particularly relevant today, as we’ve moved from a low-interest-rate environment to a higher one. Just a couple years ago, many companies were able to generate good returns using lots of debt at ultra-low interest rates. But as those same companies refinance their debt at much higher rates, many will see returns suffer. Some will not survive.
Management in place
What’s implied but not implicitly stated here is that the management team in place must be excellent. Buffett and Munger counted on the management of their operating businesses to act with an owner’s mindset and achieve excellent results. If they had to look over management’s shoulder with every new business they acquired, it just wouldn’t have worked. Identifying if a company has a top caliber CEO is as much art as science. But here’s a tip: Look back a few years and see what they were talking about. Have they stayed consistent? Did they hit their targets (or did the targets change along the way)? If it’s a CEO that’s new to the company, a great place to start is with the performance of the last company they led – before, during, and after their tenure.
Simple businesses
Any Buffett fan has likely heard the idea of investing within your circle of competence. Simply put, you should invest in businesses you’re capable of understanding. This aids you in several ways as an investor, including determining what the business is worth, what the competition looks like, and what risk factors exist. Understanding enables conviction. It helps you remain calm when stock prices inevitably fluctuate. Some investment opportunities sound exciting – A.I., flying cars, cryptocurrency – but they can be awfully hard to understand or predict results. Being uninformed makes it exceedingly difficult to be a patient long-term investor when these investments hit a rough patch. If you stick with simple businesses, you’re more likely to know if your stock is down because of a fundamental change to the business or simply market panic.
An offering price
The point here isn’t just knowing the price. If you’re investing in publicly traded stocks, finding a price will pose no difficulty. But it’s the first step to determining if you’re paying a fair price for the business. Sometimes Berkshire Hathaway made multiple acquisitions in a year. There were other years when zero acquisitions were made. It’s better to be patient than to overpay.
The world has changed a lot in 40 years. Actually, it changed a lot during the lifetime of this ad. You see, this wasn’t a one-time affair. Buffett continued to run this same ad in his annual letter to shareholders for many consecutive years.
During that time, much of the world plunged into the worst recession since World War II. Escalating tensions with Russia during the Cold War moved the doomsday clock to three minutes to midnight. The AIDS epidemic began and would ultimately claim 6x more lives globally than the COVID-19 pandemic. The Berlin Wall fell. The computer found its way into homes. A lot was changing. Some good. Some bad. Things to worry over. Things to be hopeful for. Same as today.
Through all of it, the ad – and what Buffett and Munger wanted in a business – didn’t change. They stuck to their list.
Understanding the list is easy. Sticking to it in a rapidly changing world is hard. But it worked then. And it will work today.
MEET THE AUTHOR
Michael Joseph, CFA
Michael is a Portfolio Manager and Deputy Chief Investment Officer at Stansberry Asset Management. His duties include sourcing investment opportunities and conducting ongoing due diligence across SAM’s portfolios. Michael co-manages our Income and Tactical Select strategies.
