COLVIN: Arnold Schwarzenegger thinks maybe Warren Buffett can solve one of
America's worst financial messes, the California state budget. Meanwhile, Buffett was
forced yesterday to disclose the name of a stock he's been buying, which he hates to do
because other investors then force the price up and he can't buy more. We'll tell you
which stock it was. And Barron's says his company's stock, at $76,000 a share, may be
underpriced. How can the rest of us invest like America's master investor? Robert
Hagstrom is author of The Warren Buffett Way, and he runs the Legg Mason Focus Trust
mutual fund on Buffett's principles; it's up 42% this year. David Braverman of Standard
and Poor's has created a Warren Buffett stock-picking screen. And Charles Lieberman is
chief investment officer of Advisors Financial Center. He thinks you and I can actually
outperform Buffett.
Well, guys the mystery stock that Buffett finally had to disclose was Automatic
Data Processing, ADP. He bought it in March, or bought most of it in March. It is since
up about 30%, so another great Buffett stock pick. That said, Robert, it's not in your
portfolio. David, it's not on your list. What happened? How did this one get past you?
HAGSTROM: Well, you know, we can't get them all, we can't get them all. But
it's still kind of a common Buffett-type stock. You know, a company whose business is
simple to understand, has a consistent operating history.
COLVIN: People may not know it processes checks.
HAGSTROM: Checks, yes. And you can kind of think for the next 5 to 10 years, it
will probably be doing pretty much the same thing going forward, and those are the type
of businesses Warren likes to be involved in.
COLVIN: Why wasn't it in your screen?
BRAVERMAN: Well, what we look at are basically high margin companies, high
ROE companies.
COLVIN: Return on equity.
BRAVERMAN: Return on equity. Companies that have returned at least a dollar's
worth of profits in terms of increasing market value.
COLVIN: For every dollar of retained earnings, as he likes to say.
BRAVERMAN: For every dollar of retained earnings, exactly. And our screen is not
necessarily the same stocks that Buffett is going to necessarily buy, but it's sort of an
instructive way of starting one's research. And our screen has done very well, about twice
the S&P 500 over the last eight years.
COLVIN: Yeah, it's done terrifically overall. That's for sure. Chuck, you recently
wrote, "many investors may be surprised to know they can compete successfully with
Berkshire's current portfolio." Now I think that's fair to say they would be surprised to
hear that. What makes you say so?
LIEBERMAN: Well, to start with there are actually investors or funds out there
that actually try to mimic Buffett. They buy the same kind of stuff that he buys. When he
buys a company out completely, they buy companies in the same industry that are very
similar in structure. And Buffett actually is saying very negative things about the market.
He's actually been fairly negative for a while, suggesting that investors shouldn't expect
to earn more than 6 or 7 percent annually over the next decade, and that's the comment
that he made that I most objected to, because I think it's fairly easy for investors to
exceed that kind of return over the next 10 years.
COLVIN: Robert, if you had to distill Buffett's investing philosophy into a sentence
or so, what would it be?
HAGSTROM: Well, he said it probably better than I can say, but he said
"investing is most intelligent when it's business-like." That quote was actually from his
mentor, Ben Graham. But for Buffett everything is reduced to the idea that you're running
businesses, you're buying businesses, your portfolio is a collection of businesses. And
when you think that way, your investment strategies change.
COLVIN: So you're not buying a stock, as it were. You're buying a business. You're
buying a company.
HAGSTROM: And you're thinking about that company as if you were the owner.
If your whole net worth, your family's net worth was tied up in this business, what's
going to be very important to you? Things like cash, high returns on capital, sustain
ability of the business model over time. These are the things that Buffett is talking about,
and as you well know, common stocks are nothing more than derivatives of business
value. So if you get the business value right, you're going to figure out where the stock
price goes over time.
COLVIN: And the things Robert is talking about are the things that are the elements
in your screen, David.
BRAVERMAN: Exactly. And I think another tied to what Robert said is taking a
look at all sorts of asset classes and looking for undervalued assets wherever they may be.
In the last quarter, I think some investors were surprised to see how good Mr. Buffett's
timing was in selling large quantities of Treasury bonds. There was a large gain made in
the last quarter and his timing was nearly perfect.
COLVIN: As it so often is. I think June 13th was the date when rates hit their absolute
low, which means prices were at their highest, and that's around when he was bailing out.
BRAVERMAN: Exactly right.
COLVIN: David, you have, your screen picks out about 30, 25 or 30 stocks, but
we've asked you for five of them: H&R Block, Citigroup, FactSet Research, Johnson &
Johnson, and Oracle. Now four of those five are famous companies. One of them isn't,
FactSet Research. What is it?
BRAVERMAN: FactSet is a company that does financial database analysis. A lot of
professional investors use them to analyze companies to do attribution analysis on their
portfolios, and it's a growing company. And the reason it makes the screen again is that it
has high margins, high return on equity.
COLVIN: Robert, you have a lot of companies in your... well, first of all, we should
say your fund typically holds only about 20 or so stocks.
HAGSTROM: About 20 stocks.
COLVIN: Much fewer than most mutual funds. But many of them are the kinds of
companies that you wouldn't expect Warren Buffett to own. They're in technology one
way or another, things he has said he's not comfortable with. Now how is it that they end
up in your fund?
HAGSTROM: Well, we're very fortunate to be a member of the Legg Mason
Fund's management team, run by Bill Miller, and he's quite an exceptional stock picker
himself. And Bill's philosophy is that we can take Warren's methods and apply them to
technology, to the Internet space, telecommunications. And we've done that with
tremendous success in our fund's group. And so really what we're trying to do is trying to
find that next franchise, the next Coca-Cola and the next Gillette, but likely it's going to
perhaps be in the Internet space, telecommunications. So our portfolio is trying to find
that next franchise out the next 5 and 10 years, and that's where we're investing.
COLVIN: The things that he might not be comfortable with, but that still have the
criteria he would demand.
HAGSTROM: Yeah. The only difference is that the landscape, the economic
landscape changes a little more swiftly than carpets and paint and furniture, and so you
have to be a little bit more nimble, a little bit more on your feet about it. But I think if you
look at the high returns that people are going to be expecting, I think this is the area that
you have to work in. And what we're simply doing is taking the Buffett methodology, the
Buffett principles that are based in our process and apply them out into these new
economies, new industries.
COLVIN: Chuck, to beat Buffett's portfolio, do you advocate that investors invest
along classic Buffet lines?
LIEBERMAN: Absolutely. Buffett, as was suggested, looks at things that really
matter. It helps if you think of yourself as owning a business. Think of what you want out
of that business. You want cash flow, you want a high return on your investment. Those
are the things that Buffett looks for, and those are exactly the kinds of things that I look
for in the portfolios that I manage.
COLVIN: A few of the things Buffett has said over the years almost everything he
says is quotable it seems one of the things he said was "look at market fluctuations as
your friend rather than your enemy. Profit from folly rather than participate in it." David,
what would he say about the times we are in right now in the market? Is this folly?
BRAVERMAN: I think he would take a look at a lot of different asset classes and
look for those areas which are undervalued. I think if you take a look at some of the areas
that he's been emphasizing, some of the electric utility areas, some of the
telecommunication areas, he's looking for undervalued assets and finding mechanisms to
rationally invest in those.
COLVIN: Robert, what do you say?
HAGSTROM: Yeah, I think you always have to take advantage of "Mr. Market,"
as he says. You know, the old quote from Ben Graham, in that you want to make sure that
you understand what fluctuations are in the market. You're not to be driven by them;
you're to take advantage of them. So that's certainly the way we play at Legg Mason.
COLVIN: Another thing he has said is "our favorite holding period is forever." Do
you run your fund that way?
HAGSTROM: Well, our turnover ratios are very below average. My fund is about
70%. Our fund's group average is probably more like 40%. So we are very long-term
investors. But I think, and you look at kind of the new economy type stocks, the
landscape changes quicker. I think the competitive advantages are slower I mean, I'm
sorry, competitive advantages are much faster being worked out. In which case I think
your turnovers may go up a little bit. It's not going to be like Coca-Cola and owning it for
a hundred years. It's going to be a little different than that.
COLVIN: Which is sort of what he did. Now of the 20 or so stocks in your portfolio
now, who do you really like?
HAGSTROM: Well, one of our favorite stocks is InterActiveCorp, the old USA
Interactive.
COLVIN: Barry Diller's company.
HAGSTROM: Yeah, Barry Diller's company. It's an Internet service provider for
travel, hotels and things like that. And we're very keen on the Internet service providers
as a whole, because their business models are just fantastic, high cash returns, triple digit
return on invested capital business models, and global opportunities. These are $20, $30
billion companies that can get three, four, five times bigger from here.
COLVIN: Let me ask you about another way to play Warren Buffett, which is to buy
his stock, Berkshire Hathaway stock. Now at $76,000 a share, it's a little rich for most
people, although there's a class B stock that is 1/30th of that price. Using Buffett's own
criteria, how would you evaluate Berkshire Hathaway's stock at its current price?
BRAVERMAN: Well, currently we have an accumulate ranking on the stock. It's
our second highest ranking, and we believe that the stock could go up probably 10 or 15
percent from current levels within the next 12 months. You know, we like the stock and
earnings have done extraordinarily well on a year-to-year basis. They've managed at this
point to have better underwriting results from their General Re?? subsidiaries.
COLVIN: The insurance businesses, yeah. Robert, what do you say?
HAGSTROM: I'm probably not too far different from David. I think plus or minus
10 or 15 percent is where the stock looks to us. But we're trying to achieve returns that
are going to be higher than that, although we think Berkshire is a fantastic company. We
owned a great deal of it in '99 when the stock was 40, 42,000. We thought it was worth
70, and so we made a good deal of money then. But here at the $75,000 range, I think
there are things that we can to our portfolio that will outperform Berkshire, and that's
what our job's going to be.
COLVIN: That's what you're talking about too, Chuck. Barron's recently said it's
entirely possible the stock could approach $100,000 by the end of 2004. What do you
think?
LIEBERMAN: Well, that could happen in the stretch, but I think if that happened,
he'd probably still outperform by, for example, I prefer the insurance companies. I think
there are a number of insurance companies that will do at least as well as Berkshire's and
probably better. You don't get some of the baggage in the Berkshire Hathaway
environment by going to some of the more focused situations.
COLVIN: You know another thing people notice about the companies Buffett likes is
that he really likes brands. He seems to have discovered they have a certain value, so a
big investor in Coke, Gillette, Wrigley's, Benjamin Moore, Fruit of the Loom, Dairy
Queen. Why does he like them so much?
BRAVERMAN: Well, they're basically enduring. They don't have the long-term
changes. He is looking for a product life cycle and if there's a brand that has a long
product life cycle. And that's one of the reasons that I think he's steered clear of
technology up till now. He'd much prefer something that he knows is going to be around
in 30 years.
COLVIN: I can well understand. We've got to cut this short because we're out of
time, but David, Robert, Chuck, thanks so much for your views.
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