Also by Mary Buffett and David Clark Buffettology The Buffettology Workbook RAWSON ASSOCIATES SCRIBNER 1230 Avenue of the Americas New York, NY 10020 Copyright © 2002 by Mary Buffett and David Clark All rights reserved, including the right of reproduction in whole or in part in any form SCRIBNER and design are trademarks of Macmillan Library Reference USA, Inc., used under license by Simon & Schuster, the publisher of this work Set in New Baskerville Library of Congress Cataloging-in-Publication Data Buffett, Mary The new Buffettology: the proven techniques for investing successfully in changing markets that have made Warren Buffett the world’s most famous investor / Mary Buffett and David Clark p.cm Includes index Investments Buffett, Warren I Clark, David, 1955 II Title HG4521.B7692 2002 332.6—dc21 2002068110 ISBN-13: 978-0-7432-3411-5 ISBN-10: 0-7432-3411-1 Visit us on the Word Wide Web: http://www.SimonSays.com Pluralitas non est ponenda sine neccesitate This book is dedicated to Charlie Munger and Billy Occam, who gave, respectively, to investing and science the idea that the simplest explanation is usually the best Acknowledgments We wish to thank first and foremost Warren Buffett; although he did not participate in the writing of this book, we are forever indebted to him for his wisdom and generosity over the years His genius as an investor will someday be overshadowed by his tremendous philanthropy The Buffett Foundation, the final repository for the masterpiece he calls Berkshire Hathaway, will ultimately be the world’s wealthiest charitable foundation, providing future generations with the benefits of his earthly passion for investing We also wish to thank our publisher, Eleanor Rawson, for her inspiration and guidance She is the best of her breed and we would be lost without her We also would like to thank our editor, Lisa Considine, whose pen kept ours straight and true She is a credit to her craft And a special thank you to our assistant editor, Anne Bartholomew, and our amazing copy editor, Steve Boldt We would also like to thank Simon & Schuster attorneys Jennifer Weidman and Emily Remes for their skillful guidance These people are solid proof that the staff at Simon & Schuster is the best in the business We owe an enormous debt of gratitude to: Sam, for being Mary’s knight in shining armor To Erica and Nicol, for being wise beyond their years and two of the best daughters a mother could ever ask for To the girls’ father, Peter Buffett, for the wonderful years that we had together To the magical and mystical Sabrina Benson, who, with a simple wave of her wand and a phone call, makes the impossible happen To Kitty O’Keefe and Shih’hua Liu, for their friendship and brilliance To Patti, for her love and support To Cindy Connolly Cates, who suffered through our earlier drafts and who remains always the silent third author We could not and would not write without her To Ben Platt, for helping us burn out the demons after a hard day’s night To Jessica Schemm, for playing the enchanting muse To Eric Hoffman, for being the best poet and proofreader that any author could ask for To Gerry Spence, John Johnson, and Robert Rose, for their words of encouragement when they were much needed To Tim Vick, the most intellectually honest man on Wall Street, for his insight and thoughts To Pauline Macardican, for being an angel in disguise To Fritz Perlberg and Rob Gritze, for their friendship and wisdom To Valerie Schadt, for being everything that counts To Roger Lowenstein, the best writer on Wall Street, for his reflections on Warren and Berkshire Hathaway To Andy Kilpatrick, for being the consummate Berkshire historian and a charming Southern gentleman To Andy Clark, for the historical research To Vincent Waldman at Manatt, Phelps & Phillips, for making the deal happen To Terry Rosenberg, for his creative spirit To Robert E., for his constant friendship and support through the most trying of times And most important, to the beautiful Kate Benecke for her love Contents Disclaimer Foreword: A Few Personal Things About a Very Private Billionaire Introduction: How Warren Buffett Turned $105,000 into $30 Billion he Answer to Why Warren Doesn’t Play the Stock Market—and How Not Doing So Has Made Him America’s Number One Investor ow Warren Makes Good Profits Out of Bad News About a Company ow Warren Exploits the Market’s Shortsightedness ow Companies Make Investors Rich: The Interplay Between Profit Margins and Inventory Turnover and How Warren Uses It to His Advantage he Hidden Danger: The Type of Business Warren Fears and Avoids he Kind of Business Warren Loves: How He Identifies and Isolates the Best Companies to Invest In sing Warren’s Investment Methods to Avoid the Next High-Tech Massacre terest Rates and Stock Prices—How Warren Capitalizes on What Others Miss lving the Puzzle of the Bear/Bull Market Cycle and How Warren Uses It to His Advantage How Warren Discerns Buying Opportunities Others Miss Where Warren Discovers Companies with Hidden Wealth Financial Information: Warren’s Secrets for Using the Internet to Beat Wall Street Warren’s Checklist for Potential Investments: His Ten Points of Light How to Determine When a Privately Held Business Can Be a Bonanza Warren’s Secret Formula for Getting Out at the Market Top Where Warren Buffett Is Investing Now! tock Arbitrage: Warren’s Best-Kept Secret for Building Wealth For the Hard-Core Buffettologist: Warren Buffett’s Mathematical Equations for Uncovering Great Businesses Thinking the Way Warren Does: The Case Studies of His Most Recent Investments Putting Buffettology to Work for You Index Disclaimer This publication contains the opinions and ideas of its authors It is not a recommendation to purchase or sell the securities of any of the companies or investments herein discussed It is sold with the understanding that the authors and publisher are not engaged in rendering legal, accounting, investment, or other professional services Laws vary from state to state and federal laws may apply to a particular transaction, and if the reader requires expert financial or other assistance or legal advice, a competent professional should be consulted Neither the authors nor the publisher can guarantee the accuracy of the information contained herein The authors and publisher specifically disclaim any responsibility for any liability, loss, or risk, professional or otherwise, which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this book rench, Kenneth riedman, Ike urniture Brands International durable competitive advantage of value of, relative to treasury bonds urniture businesses see also specific companies W Woolworth Company Gallaher Group, Plc Gannett Corporation accuracy of 1996 projections for case study of competitive advantage of initial rate of return of per share growth rate for projected annual compounding return rate of projecting future stock value of stock of, as equity/bond Gates, Bill Buffett and Geico Buffett’s student research on as buying opportunity Graham and share repurchase program of General Electric (GE) General Foods Corporation General Motors (GM) operational costs of return on total capital and shareholders equity of General Reinsurance, Berkshire’s merger with Gillette Gillette, King Camp Golub, Harvey ood news phenomenon, stock and GPU Inc Graham, Benjamin Buffett and Geico and long-term projections and Mr Market model of stock arbitrage and Graham, Katharine Guide to Business Periodicals Gulf War (1990), as buying opportunity H&R Block case study of durable competitive advantage of initial rate of return, relative to bond value operational costs of projected annual compounding return rate of return on total capital and shareholders’ equity of share repurchase program of stock of, as equity/bond ealth care reform, Clinton agenda of Hershey Foods Hewlett-Packard igh-tech stocks bubble in Buffett and investment in at top of market (1999) ousehold items, brand-name see also specific companies HRPT Properties Trust BM ncome statements ndex funds nflation: durable competitive advantage and Federal Reserve and price-competitive businesses and nformation businesses nfoUSA nside Intel (Jackson) nsurance, insurance industry accumulated earnings tax and Berkshire Hathaway and car recession in see also specific companies ntel competitive advantage of nterest rates: Federal Reserve and stock prices affected by U.S economy and nternet financial services and information on stock arbitrage and stocks, see high-tech stocks trading on nternet portal companies, as price-competitive nternet service providers (ISPs), as price-competitive nterpublic Group of Companies nventory turnover: durable competitive advantage and of price-competitive businesses profit margin interplay with Investing for Future Values” (Wiese) nvestment banks: competitive advantage of long-term debt of at top of bull market nvestment float nvestors, investments: Buffett’s and Berkshire’s recent and historical case studies of recent circle of confidence and contrarian in emerging industries important questions for Internet information for screening criteria for short-term motivated, see momentum investing see also specific investments ackson, Tim DN Realty ewelry-store chains ohns Manville Berkshire purchase of ordan’s ustin Industries Kaiser Aluminum & Chemical Corp Kellogg’s KFC Kirby Vacuum KKR Knight-Ridder Newspapers Kraft/General Foods abor, organized, durable competitive advantage and a-Z-Boy Inc case study of competitive advantage of initial rate of return relative to bond value projected annual compounding return rate of stock of, as equity/bond earning Company, Mattel and ehman Brothers evi’s iz Claiborne ocal monopoly ong-Term Capital os Angeles Times ow-cost producers: durable competitive advantage of price-competitive businesses and ucent McDonald’s Corp magazines Marion Merrell Dow, Inc market cap Mattel Learning Company acquisition by Media General Inc memory-chip manufacturers, as price competitive Merck & Company Mercury General Corp mergerstat.com Merrill Lynch Micron Technology Microsoft momentum investing Buffett’s view of and Fed-engineered economic slowdown market efficiency and mutual funds and money-center banks monopolies: consumer local regional monopoly buying power Moody’s Investors Services Moody’s Stock Guides mortgage-backed bonds mortgages Motorola Mr Market msn.com Mueller Industries multinationals, advertising of Murphy, Tom mutual fund managers, performance pressures on mutual funds: index momentum investing and value-oriented venture capital Mylan labs NBC television network Nebraska Furniture Mart Berkshire’s purchase of durable competitive advantage of Netscape NetZero ewspapers: advertising and as regional monopolies see also specific companies New York Times New York Times Company Nexus Nike Inc Ogilvy Group il companies as price-competitive Omnicom Group perational costs of Bethlehem Steel durable competitive advantage and of General Motors of H&R Block of price-competitive businesses of Wm Wrigley Jr Company ptions market Orkin Outdoors Systems eople epsico, Inc er share earnings: of companies suffering setbacks durable competitive advantage and upward trend in of durable competitive vs price-competitive companies historical consistency of information on of price-competitive companies er share earnings, growth rate of: in companies with negative or low earnings determination of for Gannett from Gannett’s future stock value projected from projection of stock value by use of ersonal History (Graham) est control services harmaceutical industry hilip Morris as buying opportunity illsbury izza Hut laytex orsche, brand-name niche of rice-competitive companies: in boom economy brand names and bubble-bursting damage to in conglomerates contrarian investors and with durable competitive advantage durable competitive advantage businesses vs identification of inflation and inventory turnover of long-term debt of low-cost producers and management and mergers and operational costs of organized labor and per share earnings of profit margins of return on total capital of shareholders’ equity returns and share repurchases and as “sick,” riceline rice-to-earnings (P/E) ratio RNewswire rocter & Gamble rofit margins: durable competitive advantage and of emerging industries inventory turnover and of low-cost producers of price-competitive companies ate of return, annual compounding, stock prices as determinants of ate of return, initial: determination of on Freddie Mac on Gannett on H&R Block on La-Z-Boy treasury bond value relative to ate of return, projected annual compounding: for Berkshire in for Bristol-Myers Squibb determination of for Freddie Mac for Gannett for H&R Block for La-Z-Boy azor blades, disposable R C Willey Furniture Reader’s Digest eal estate investment trust (REIT) ecessions: bubbles and Federal Reserve and industry egional monopoly ental businesses eturn on total capital and companies with no net worth definition of durable competitive advantage and consistently high of General Motors vs H&R Block R J Reynolds RJR Nabisco, in management buyout offer Rollins Ruane, Bill alomon Brothers ara Lee cience of Hitting, The (Williams) cott Fetzer, Berkshire purchase of cuttlebutt approach, to financial information ears EC EDGAR Database ecurity Analysis (Graham) ecurity services ee’s, Berkshire purchase of elective contrarian investment strategy baseball and buying opportunities in, see buying opportunities contrarian investment strategy vs definition of durable competitive advantage in, see durable competitive advantage stock market pessimism and shortsightedness used in eptember 11, stock sell-off after equoia Fund ervice Master hareholders’ equity hareholders’ equity, rate of return on: analysis of average calculation of durable competitive advantage and of General Motors vs H&R Block price-competitive businesses and hare repurchases durable competitive advantage and dynamics of Geico and price-competitive business and Washington Post Company and haw Industries mart Money ports Illustrated tandard and Poor’s Stock Reports tar Furniture tock arbitrage Buffett Partnership and calculations in getting started in Internet and opportunities for risks in time factor in tock market: bubbles in, see bubbles buying opportunities in, see buying opportunities corrections and panics in efficiency of momentum investing in, see momentum investing 1929 crash of in late 1960s 1973—74 crash of 1987 crash of options trading in in 2000—2002 see also bear markets; bull markets tocks, selling of bond vs stock value in at market top war and when better opportunity presents itself when business environment changes when target price is right tocks, stock prices: bad news phenomenon and in bear markets in bull markets corporate structural changes and as determinants of annual compounding rate of return durable competitive advantage and as equity/bond, see equity/bond good news phenomenon and individual calamities and industry recessions and nitial rate of return on, relative to treasury bonds interest rates and prices of market cap and purchase of and market corrections and panics per share earnings growth rate and aco Bell axes: accumulated earnings and Coca-Cola sale corporate ax preparation services elevision industry advertising and durable competitive advantage and see also specific companies enneco Offshore exas Instruments, BA-35 Solar financial calculator of extile industry, as price-competitive heory of Investment Value, The (Williams) ime ime Inc imes Mirror oiletries, brand-name orchmark Corp ravelers Group avel industry, after September easury bonds, U.S., value of, relative to initial rate of return urner, Ted 0th Century Insurance United Airlines USA Today, USG Corp UST alue investing in bear markets Buffett Partnership and mutual funds and alue Line Investment Survey, enture capital funds Wall Street Journal Wal-Mart Stores Walt Disney Company in Capital Cities merger war, as buying opportunity Warner-Lambert Company Washington Post Washington Post Company share repurchase program of Wells Fargo as buying opportunity Wendy’s Wesco Financial Wiese, Robert F Williams, John Burr Williams, Ted Wm Wrigley Jr Company durable competitive advantage of operational costs of workout situations, see stock arbitrage World Book Wyeth Yahoo! hypothetical investment in Yum Brands ... in New Baskerville Library of Congress Cataloging -in- Publication Data Buffett, Mary The new Buffettology: the proven techniques for investing successfully in changing markets that have made Warren. .. public that is only interested in investing in funds that earn top performance ratings in any given year Imagine a mutual fund manager telling his or her marketing team that their fund ranked in the. .. perspective investing, The New Buffettology takes an in- depth look at how Warren uses the stock market’s pessimistic shortsightedness as a catalyst for investing in some of the great businesses of