Buffett's Investment Philosophy Analysis
1.What is intrinsic value from Warren Buffett's perspective and why is it given such importance? How is it estimated? What are the alternatives to intrinsic value and why does Buffett reject them?
According to Buffett, intrinsic value is defined as “the present value of future expected performance”’. Buffett goes on to use the cost of a college education versus the pros of having a college education to clarify this thought. If a student goes to an incredibly expensive school and earns a degree in medicine, but ends up deciding to work solely as a volunteer, the book value of the education exceeds the intrinsic value of the college education purely on a monetary level. If the same student becomes Chief Surgeon, the intrinsic value of the college education far exceeds the book value of the education. Book value, or the number value, is something that Buffett warns against using when valuing investments. To him, book values do not accurately represent the economic reality, just the accounting reality. This ties into his definition of intrinsic value. The economic value of an investment depends heavily on outside influences such as demand, popularity, opinion, price, name, future worth, etc. Buffett believes that nothing should be valued solely based on a number alone.
2.Please critically assess Buffett's investment philosophy, and prepare to identify points where you agree or disagree with him and why.
Looking into the criteria specifically on how acquisitions will be handled was very interesting. Making after tax income minimum, a management team, and a consistent earning power requirements is an excellent idea. These things in particular will cut the risk of loss in profit due to any merger or rebranding. The fact that the management will stay the same will help ease the transition of the acquisition and allow for the company to continue to work and provide the same excellent performance as before. The two main requirements I find myself disagreeing with are the requirements about the simple companies only, and the non-negotiation of prices. The simple company's only requirement could honestly be more from the time period, but I think this is an error made on Buffett's behalf. I acknowledge that at the time there were so many new pop up companies branding themselves as “tech” in order to drive up the stock bubble, but this was not always the case. The true, honest, money making tech companies made the cut and lasted through the bursting of the bubble. Buffett could have made some serious profit by acquiring a few of these smaller tech companies. I do appreciate the mentality of Buffett though; he is the leader of his company and if he cannot understand it, he wants not parts of it. I cannot disagree with that. As far as the selling price of the companies goes, I think this almost goes directly against his previous thoughts on the intrinsic values of an investment. If Buffett is not willing to negotiate or rethink the price offered for a company, I think he is goin back on what he has said in how he values an investment. This can also be the argument against his statement that future projections are worth nothing to him when it comes to acquisitions.
I specifically want to focus on the investing philosophy #5. Risk and discount rates. To me, this feels like an easy way out, the "play it safe" method. Growing up I always heard "no risk, no reward" and while I understand that absolutely cannot always be applied to the stock market and business decisions, I think it is is impossible for risk to not happen sometimes. Making any decision based on a trend, data valuation, etc will always be a risk. There will never be enough information. There is never 100% certainty. Warren states that risk comes from not knowing what you are doing. I disagree. Even if you are an expert in the field, there is still risk of failure, loss, things going astray. The world, the stock market, the behavior of a person, the behavior of monetary value, all of it can change with the blink of an eye and there is no way to be sure of it 100%. Risk is inevitable and therefore should be taken into account always.
3.What is the possible meaning of changes in the stock price of GEICO and Berkshire Hathaway on the day of the acquisition announcement?
One reason for the increase in the price of the stock from $55.75 to $70 can be justified by the fact that in order to go through with the acquisition, Berkshire needed people to sell them the shares, so they are offering above market prices to motivate the sale of the shares. GEICO benefits from this because the take-over is expected to bring GEICO an increase in net value which will lead to increased company profitability for Berkshire. This was seen before in 1976 to 1980 when Berkshire first started to buy shares in GEICO; Berkshire’s original stake grew from $45.7 million to $1.9 billion, GEICO paid an increasing dividend each year, and the rate of return on large company stocks was 13.5%.
