Buffett quote on small growth companies

[LR1400]

I recently read a quote, supposedly from Buffett, where he states he would buy smaller, young, newly public companies were he a young man. This was due to their potential for long term earnings growth.

 

I thought I had saved it but I didn't. The topic he was discussing was related to young investors and investors with smaller sums as well as qualitative versus quantitative investing.

 

Thanks for the help.

[CorpRaider]

Sounds more like something Munger said fairly recently, but I don't have a quote or source.  He does tend to "rift fantastique"/bullshit a lot more than the big chairman.

[blainehodder]

https://old.ycombinator.com/munger.html

 

How do you get into these great companies? One method is what I'd call the method of finding them small get 'em when they're little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it's a very beguiling idea. If I were a young man, I might actually go into it.

[LR1400]

https://old.ycombinator.com/munger.html

 

How do you get into these great companies? One method is what I'd call the method of finding them small get 'em when they're little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it's a very beguiling idea. If I were a young man, I might actually go into it.

 

That's it!

 

Thanks.

[LC]

Be careful how you interpret the quote:

 

And it's a very beguiling idea. If I were a young man, I might actually go into it.

 

be·guile

bəˈɡīl/

verb

gerund or present participle: beguiling

1.

charm or enchant (someone), sometimes in a deceptive way.

[wachtwoord]

So the young man in the quote should be read as naive ;)

[scorpioncapital]

Perhaps he's referring to the difficulty in finding the next winner early, hence the deceptive part. If you read Philip Fischer, it's exactly what he's advocating, not necessarily IPO, but a real full on effort to think about and find the next 10 to 100 bagger growth stock, if not at the baby stage, at least at the junior stage.

 

 

[Investor20]

I thought the argument for buying smaller companies is lack of competition from fellow investors.  Buffett of course talks about fat wallet being the enemy of superior investment results. 

 

Buffett specifically said he wont buy Facebook or an IPO for that matter. Below is the link

 

http://money.cnn.com/2012/05/06/news/buffett-facebook/

 

"The idea that something coming out...that's being offered with significant commissions, all kinds of publicity, the seller electing the time to sell, is going to be the best single investment that I can make in the world among thousands of choices is mathematically impossible," said Buffett

 

To me the most important criteria is "seller electing the time to sell".  By any measure Facebook management would know lot more than I can about the Facebook prospects.

[LR1400]

Perhaps he's referring to the difficulty in finding the next winner early, hence the deceptive part. If you read Philip Fischer, it's exactly what he's advocating, not necessarily IPO, but a real full on effort to think about and find the next 10 to 100 bagger growth stock, if not at the baby stage, at least at the junior stage.

 

I need to read Fischer. I have one on my shelf but I've only skimmed it.

[rb]

I thought the argument for buying smaller companies is lack of competition from fellow investors.  Buffett of course talks about fat wallet being the enemy of superior investment results. 

Not really anymore, there's so much PE money out there chasing small cos, that it's probably easier to find big cos cheaper. As surprising as that may sound.

[Investor20]

I thought the argument for buying smaller companies is lack of competition from fellow investors.  Buffett of course talks about fat wallet being the enemy of superior investment results. 

Not really anymore, there's so much PE money out there chasing small cos, that it's probably easier to find big cos cheaper. As surprising as that may sound.

 

I do agree that small companies may not be best investment, but for a different reason.

 

Russell 2000 P/E is being reported as NIL

 

On the other hand:

6% of companies make 50% of U.S. profit

http://www.usatoday.com/story/money/markets/2016/03/02/6-companies-make-50-us-profit/81175914/

 

However, the logic I have read about small money should invest in small companies is when we keep a small portfolio (10-20 stocks), it becomes very difficult for a larger fund to find enough liquidity in smaller companies.  So, whoever PE is good at it, they will soon be above the threshold - I read it as 200 million - at which point have to get into higher EV value companies.  Based on this logic, there is always room for smaller money to invest in smaller companies.

 

I personally struggled to find small companies that I like enough to buy.  But may be because Russell 2000 P/E is negative I am not able to find small companies that attracts me as a value investor, or may be as you mentioned too much PE money, or may be my research is flawed.

 

 

 

[scorpioncapital]

Google was a 10 bagger. Now it's 550 billion so that means it ipo'ed at about 55 billion. The sweet spot can be very large. I'd say even up to 10-20 billion is small enough to make a difference.

 

 

 

 

 

[LR1400]

I know I will get annihilated here, but I have had more success buying and selling growth companies in a manner similar to momentum investors. When going value I got virtually no return.

 

Are there any others who have transitioned to more of a momentum approach?

 

I still believe in the Buffett idea of owning a business forever, though often this is unrealistic. Market forces change and can do so rapidly or slowly to the point you notice too late. And if this is in a privately held business, you can often be stuck.

 

I like the idea of selling if the price goes down a certain percentage as opposed to averaging down. Then redeploy the capital somewhere else.

 

 

[ScottHall]

I know I will get annihilated here, but I have had more success buying and selling growth companies in a manner similar to momentum investors. When going value I got virtually no return.

 

Are there any others who have transitioned to more of a momentum approach?

 

I still believe in the Buffett idea of owning a business forever, though often this is unrealistic. Market forces change and can do so rapidly or slowly to the point you notice too late. And if this is in a privately held business, you can often be stuck.

 

I like the idea of selling if the price goes down a certain percentage as opposed to averaging down. Then redeploy the capital somewhere else.

 

I still do value investments but my style has shifted towards growth over the past five years. Giving value investors grief fun, but the style can and does work in some circumstances. It's just that most of its practitioners are not skilled at the art, which is unsurprising given the wide array of Xeroxes of Xeroxes that are easily read about the subject.

 

It encourages amateurs who don't know what they're doing, which is valuable in that it gets more people into investing, but unfortunate because a lot of people let those early learnings stunt their growth.

 

Nevertheless, value can be a successful style and my view is that its core concepts make sense as a base to add upon, rather than being the whole strategy by itself. Its principles make sense, but it's important to build on top of them and figure out where the heuristics of old are no longer so useful.

 

The big problem with value investing is that many of its practitioners are essentially cultists who refuse to even try to adapt their style. It makes them intellectually lazy and, surprise surprise, they end up underperforming because of it.

 

I've found a lot of value in creating my own style of investing. It's an endeavor worth pursuing, because it's harder to have unique insights if you copy & paste from the same sources as everyone else.

 

Congratulations on your success with growth investing, it's an admirable achievement to improve your style by trying new concepts.

[LR1400]

Scott, I agree value investing does work and the core concepts make sense. It's been proven. It requires too much waiting to see and also too much riding the price up and down, often 30% or more. I would prefer to be in cash while the stock prices are down.

 

Buying and holding for years makes a lot of sense when brokerage commissions were so much higher, like say in the 80's.

 

Simply, there are other ways as well and it wouldn't surprise me if Munger followed that path were he younger.

[Cardboard]

There is no issue at all buying companies with growing earnings and sales. It should actually be what you are looking for.

 

However, when you throw out the window any kind of valuation yardstick and that you are buying simply because the company is doing great and the stock price is going up, then you become a speculator and not an investor.

 

Cardboard

[LR1400]

There is no issue at all buying companies with growing earnings and sales. It should actually be what you are looking for.

 

However, when you throw out the window any kind of valuation yardstick and that you are buying simply because the company is doing great and the stock price is going up, then you become a speculator and not an investor.

 

Cardboard

 

That is true in the definition sense. However, a person like Jesse Livermore or Driehaus, who most would call a speculators was still attempting to compound his, which is investing.

 

I personally view the terms as interchangeable as they both have the some end result goal.

[alwaysdrawing]

Most "value" investors are really good at valuing bonds.  Stable, profitable companies are basically bonds--easy to value, and thus easy to see if they are under-valued (so long as you are generally right about the future cash flows).

 

Investing in small, fast growing companies is probably closer to evaluating weighted probabilities.  Especially on the good side of the distribution, if you are right, then you will do well. 

 

What's the right value for a software company that has never made a profit and yet is growing 100%+/year with a long runway?  Doing a DCF calculation for that type of company doesn't make any sense....the values make the model useless since the discount rate, growth rate, and any risk adjustments are pulled out of thin air.  Can someone who is good at judging probabilities of those companies do well? Of course.  Can they be a value investor?  Why not?

 

I think this Bezos quote sums it up well:  "We all know that if you swing for the fences, you're going to strike out a lot, but you're also going to hit some home runs. The difference between baseball and business, however, is that baseball has a truncated outcome distribution. When you swing, no matter how well you connect with the ball, the most runs you can get is four. In business, every once in a while, when you step up to the plate, you can score 1,000 runs. This long-tailed distribution of returns is why it's important to be bold. Big winners pay for so many experiments."

 

The above is why Einhorn has done horribly--companies that seemed undervalued were really valued correctly or over-valued because the business conditions had changed (e.g. Macy's).  On the other side, he tried to look at companies like Amazon through his traditional valuation lens, and it didn't make sense, so he shorted.  He was just wrong--those trades were both disastrous because he misjudged both companies badly.  There is an argument to be made that Einhorn will be vindicated in the long term, however I doubt it.  He wasn't early--he was wrong.  Even if some of his other shorts fall by half or more, he will have still been very wrong about them (NFLX, AMZN).

 

Go back and read Bezos's letters back to the 90s.  Bezos gets it, and is probably the best businessman of all time.  Look at Netflix CEO Reed Hastings letters and discussions, including his letter to Whitney Tilson.  He was just right.  I personally don't see how you could ever short that type of company, but even moreso, I think it was knowable that those companies would do well.  I have never owned Netflix (I thought it was always overvalued), however I think I was just wrong.  I have owned Amazon (although no longer), and think that it was very widely misunderstood, and still is.

 

Anyway, my 2 cents is that people looking for what worked for value investors of the past may have opportunities again, however there are other ways to make money in investing, and understanding businesses will become more valuable of a skill than anything Graham taught on valuation.  Markets are dynamic, and what worked yesterday can not work tomorrow.  Value investing is about finding under-valued investments, not about following valuation yardsticks.

[Dynamic]

Great post, @alwaysdrawing. I particularly liked the Bezos analogy.

 

I generally think that value investing covers a number of categories.

 

Buy cheap and wait for rerating. Sell when close to fully valued or when something considerably cheaper is available.

Typically up to 2-3 year time frame. Company not likely to compound much above inflation, so need to pay tax on gains then reinvest sale proceeds and dividends in another cheap company. Rinse and repeat. This is classic Graham and Dodd. Essentially Buffett buying Berkshire Hathaway mills was such a situation, but by taking control he was able to reallocate capital into other investments internally. In fact BH mills were in terminal decline.

 

Special Situations. Things undervalued on probabilistic basis including merger arbitrage, offering sufficient probability weighted annualized return. Return likely to be independent of market conditions. Short term gains. Need to rinse and repeat often. An example merger arbitrage is probably Berkshire's purchase of Monsanto now taken over by Bayer.

 

Solid companies at cheap prices. They distribute most of their cash but cannot reinvest it internally. You could hold forever and find good places to invest the dividends or you could sell when fully valued and have to pay taxes and reinvest elsewhere. This is how Berkshire treats See's Candies - it reinvests the dividends submitted to Omaha. See's has grown somewhat but close to inflation. Spending on expansion would be a lower return activity than Berkshire's normal investing. No need to sell so no tax realized.

 

Growth at a Reasonable price (GARP) or even downright cheap. Companies that have good internal reinvestment opportunities at high incremental rates of return. No need to sell and pay tax on gains. Dividends may eventually grow enormously and require reinvestment. Coca Cola during the temporary New Coke hiccup, American Express during the salad oil scandal, Apple focusing on the premium market but having a down year in 2016 (cheap) or in 2018 (fair price). Get it wrong and you don't lose much if you bought at a reasonable price unless it enters terminal decline like Nokia. No need to sell so no tax realized.

 

High growth companies. Amazon is an example where they spend cash flow on growth and moat building. Even at 30-40* earnings or FCF in early years the huge compounding leaves you with huge profits. Stay invested and you'll reap huge returns. Get it wrong and you could lose big. No need to sell so no tax realized.

 

Most sound value investments on the long side fit into that spectrum from rinse and repeat being required to never selling unless the story truly changes.

[LC]

I like the categories, Dynamic. I fit into the : Solid companies at cheap prices/Growth at a Reasonable price (GARP) or even downright cheap buckets myself. The first I find hard because I am buying usually crappy businesses, the second I am not good putting odds on merger arb, and the last I usually don't have the expertise to know when high growth is sustainable or a fleeting image.

[Dynamic]

I'm pretty much the same LC, but tending towards GARP and highly concentrated positions. This has met my goals and my tax consequences are minimal even if I do change horses now and again.

 

High growth is beguiling but I'd find it difficult to do. The best approach is perhaps for things like Amazon where you adjust some expenses like R&D and advertising to amortize them over their expected life. Adjusted earnings then are much higher and valuation doesn't look so stretched near their low points. The beauty is that you only need a moderate initial position to have a meaningful impact if it becomes a 10+ bagger. It's something I'm looking at with a view to taking advantage of temporary price declines, but I'll still meet my goals with GARP if I miss such an opportunity.

[Shane]

I thought the argument for buying smaller companies is lack of competition from fellow investors.  Buffett of course talks about fat wallet being the enemy of superior investment results. 

 

Buffett specifically said he wont buy Facebook or an IPO for that matter. Below is the link

 

http://money.cnn.com/2012/05/06/news/buffett-facebook/

 

"The idea that something coming out...that's being offered with significant commissions, all kinds of publicity, the seller electing the time to sell, is going to be the best single investment that I can make in the world among thousands of choices is mathematically impossible," said Buffett

 

To me the most important criteria is "seller electing the time to sell".  By any measure Facebook management would know lot more than I can about the Facebook prospects.

 

We all know FB went on to deliver tremendous returns following the IPO.  I believe PE/VC funds have a finite life on most of their assets and don't really have the choice of when to sell in some circumstances.