Warren Buffett Has a Big “Problem”

Everyone knows Warren Buffett. As the dean of value investing in the U.S, the Chairman and CEO of Berkshire Hathaway (BRK-B) draws thousands of people to his annual meetings in Omaha.

But where did Warren Buffett learn how to invest? Who was his teacher?

The answers: Columbia Business School and Benjamin Graham.

Warren Buffett earned his bachelor’s degree at the University of Nebraska, and then enrolled at Columbia specifically to learn from Benjamin Graham; Graham was a famous value investor of the time, though in no way as famous as Warren today. Soon after, Warren joined Mr. Graham in an investing partnership, and a few years later, Warren struck out on his own.

He’s done quite well.

But the biggest problem Warren Buffett has today is that he has too much money to manage! With more than $550 billion in assets, the Chairman of Berkshire Hathaway can no longer invest in the little (or even mid-sized) businesses that he built his reputation on.

Instead, he’s restricted to large and giant companies, which limits his ability to hit home runs.

Now, Warren is not exactly complaining about this limitation; he knows that complaining doesn’t help. But he has mentioned that he longs for the days when he could discover a little-known business with great upside potential, get on board without making waves, and then ride it to triple-digit profits.

Happily, you can still invest this way, and can get the results that Warren Buffett no longer can.

All you need to do to find these companies is to read the weekly wisdom of Cabot’s own Roy Ward. Roy will tell you what to buy—and why. He’ll tell you what price to pay. And he’ll tell you when to sell, collect your profits, and move on.

For example, just last month, Roy sent the following email to his readers: 

“Sell Alert: Baxter International (BAX 44.30) reached its Minimum Sell Price of 44.77 yesterday, April 27. The company reported solid first-quarter earnings, and management provided an upbeat forecast for the remainder of 2016. However, BAX shares have surged to a new all-time high and are now overvalued at 24.1 times current earnings per share. …

“Baxter International was first recommended in November 2013 at 37.37. … BAX has advanced 19.8% in the past 29 months compared to a gain of 16.7% for the Standard & Poor’s 500 Index during the same time period.

“I recommend selling your BAX shares now.”

Also, a few months before that, Roy sent this email to his readers:

“Sell Alert: Nasdaq OMX Group (NDAQ 59.30) reached its Minimum Sell Price of 56.60 today, October 22. The company reported solid third-quarter financial results this morning. Revenue rose 6% and EPS advanced 11%, after revenue declined 7% and EPS increased 9% in the previous quarter. The strong revenue showing was attributed to internal organic growth, which is encouraging investors to buy NDAQ.  

“Nasdaq OMX Group was first recommended in September 2012 at 23.61. … NDAQ has advanced 139.7% in the past 37 months compared to a gain of only 41.4% for the Standard & Poor’s 500 Index during the same time period.  

“Nasdaq OMX’s current price-to-earnings ratio of 17.4 is considerably higher than the company’s 10-year average P/E of 13.2. I recommend selling your NDAQ shares now.”

Now, you might be wondering, how did Roy get so smart in the ways of value investing?

The answer is, exactly the same way Warren Buffett did!

In this case (because Roy is younger than Warren), he studied under Dr. Wilson Payne, who was one of Benjamin Graham’s students. 

Roy Ward and Wilson Payne collaborated in 1969 to turn Graham’s formulas into computer code. And Roy has been using the system ever since, in both his professional and private investing.

So what is it that made Graham’s work so special?

In short, he systematized the entire process of evaluating companies, all with the goal of finding low-risk (or no-risk) investments that would appreciate over time.

Graham liked to analyze—and quantify—a business according to six factors.

1. Profitability 2. Stability 3. Growth in earnings 4. Financial position 5. Dividends 6. Price history

More precisely, he required that a potential investment have the following:

1. An earnings-to-price yield at least twice the AAA bond yield

2. A P/E ratio less than 40% of the highest P/E ratio the stock had over the previous five years

3. A dividend yield of at least two-thirds the AAA bond yield

4. A stock price below two-thirds of tangible book value per share

5. A stock price below two-thirds of “net current asset value”

6. Total debt less than book value

7. Current ratio greater than two

8. Total debt less than twice “net current assets”

9. Annual earnings growth in the prior 10 years of at least 7% compounded

10. No more than two declines of 5% or more in year-end earnings in the prior 10 years

And this was all in the days before calculators! Granted, Graham was a whiz with a slide rule, and no doubt he did a lot of the calculations in his head.

Nevertheless, that’s a lot of work.

These days, computers make the calculations a breeze. Still the data collection process is tedious, because it involves combining data from a variety of sources, some more reliable than others. But Roy Ward does it like clockwork. And Cabot’s readers reap the benefits!


The Value Investing System


Every month, Roy tracks 44 (!) separate items that size up thousands of companies using four separate sets of factors: QUALITY, VALUE, GROWTH and TECHNICAL.

Quality encompasses measures like Current Ratio, Earnings Stability and Price Growth Stability.

Value tracks items like P/E ratio, Historical Price/Book Value relative to Current Price/Book Value, and Historical

Price/Dividend ratio versus Current Price/Dividend Ratio.

Growth looks at things like five- and 10-year Historical Revenue Growth Trends, Quarterly Earnings Acceleration and five-year Projected Cash Flow.

Technical measures things like Relative Strength, Price Stability and Industry Strength.

And there are 32 more items!

But you don’t need to worry about those details, because Roy does all the work and presents the results, each month, in a 12-page advisory that tells you in plain English what to buy and why. And for every stock, he gives you specific Maximum Buy Prices, as well as Minimum Sell Prices (i.e., target prices), and updates them in every issue.

Admittedly, there are more exciting ways to invest, and Cabot has advisories that can satisfy thrill-seekers as well.

But this is a time-tested system that works, and isn’t that the bottom line?

So, if you like the idea of buying low and calmly sitting tight …

If you like the thought of taking a vacation and not having to worry about being out of touch with the market for days at time while your stocks appreciate …

And if you like the low risk that comes from buying stocks when they’re dirt cheap, I’m guessing Cabot Benjamin Graham Value Investor is the advisory service that’s right for you.

Since inception on 12/31/95, the Cabot Value Model has provided an impressive return of 1,129.2% compared to a return of 582.2% for Warren Buffett’s Berkshire Hathaway, and just 247.3% for the Dow Jones Industrials.

And while stock performance during the first four months of 2016 has been difficult for most investors, the Cabot Value Model has gained 4.6% compared to a gain of 2.0% for the Dow Jones Industrial Average and a gain of 1.0% for Warren Buffett’s Berkshire Hathaway.


Our Next President


There’s been a lot of ink (both physical and digital) spilled over the current presidential election, and it won’t surprise you to learn that I have opinions on the matter.

However, you hired me to inform you about investing, not about politics. You have no more reason to respect my opinions about politics than I do yours about rocket science (unless, like Elon Musk, you’re an actual rocket scientist). 

So, you’ll get no words about politics from me today.

But, there are investing implications to this presidential race, and I think they are very much worth pointing out, particularly at this time when there is so much fear and uncertainty about who will be our next Chief Executive.

You see, fear and uncertainty are good things for investors.

You’ve probably heard that bull markets climb a wall of worry. Well, I think the worries we have now—and are likely to have right up until election day—can be very good for the market.

In fact, when it comes to worries, the present reminds me very much of the fears people had that when the year 2000 rolled around, critical computers would crash and banks, airlines, etc. would be paralyzed.

Remember? People stocked up on water, canned goods, flashlights and generators to prepare for this very definite risk—which even had a deadline! But pretty much everything worked fine!

More to the point, the stock market climbed that wall of worry like a scared cat climbing a tree. It was a great time to be an investor, and I think the current situation has a lot of parallels!

Thus I’m bullish for the months ahead.

As for the long-term, you can put me in the same camp as Warren Buffett.

At his recent annual meeting in Omaha, here’s what Warren said:

“Twenty years from now, there’ll be far more output per capita in the United States in real terms than there is now. In 50 years, it’ll be far more. No presidential candidate or president is going to end that. They can shape it in ways that are good or bad, but they can’t end it.”

Sincerely, 

Timothy Lutts

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