Monthly Archives: November 2009

Buffett on How to Allocate Captital

At the recent CNBC Town Hall Event at Columbia Warren Buffett and Bill Gates: Keeping America Great, Buffett was asked how an individual investor should allocate capital.

QUESTION: Hi, I’m Brian Seedabalker. I’m a second-year student. Mr. Buffett, it’s great to see you again. I was on the trip to Omaha last month. Thank you for hosting us. My question is, how would you recommend an individual investor who follows the Graham and Dodd philosophy to allocate their capital today?

BUFFETT: Well, it depends whether they are going to be an active investor. Graham distinguished between the defensive and the enterprising and that. So if you are going to spend a lot of time on investment, you know I just advise looking at as many things as possible and you will find some bargains. And when you find them, you have to act. It doesn’t — it hasn’t changed at all since I was here in 1950, 1951. And it won’t change the rest of my life. You start turning pages. When I got out of school, I turned every page in Moody’s 10,000-some pages twice, looking for companies. And you have to find them yourself. The world isn’t going to tell you about great deals. You have to find them yourself. And that takes a fair amount of time. So if you are not going to do that, if you are just going to be a passive investor, then I just advise an index fund more consistently over a long period of time. The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Most of you don’t look like you are overburdened with cash anyway. [LAUGHTER] Cash is going to become worth less over time. But good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it.

BECKY: Does that mean you think we are through the roughest times? You had always kept the cash word around, too.

BUFFETT: We always keep enough cash around so I feel very comfortable and don’t worry about sleeping at night. But it’s not because I like cash as an investment. Cash is a bad investment over time. But you always want to have enough so that nobody else can determine your future essentially. The worst — the financial panic is behind us. The economic spillout which came to some extent from that financial panic is still with us. It will end. I don’t know if it will end tomorrow or next week or next month. Or maybe a year. But it won’t go on forever. And to sit around and try and pick the bottom, people were trying to do that last March and the bottom hadn’t come in unemployment and the bottom hadn’t come in business but the bottom had come in stocks. Don’t pass up something that’s attractive today because you think you will find something way more attractive tomorrow.

(read entire transcript or watch video)

Key takeaways:

1. To allocate capital, you need a good search strategy. This requires a lot of hard work, “turning pages” as Buffett calls it. See earlier postings on “Search Strategy” for ideas on how to put together an effective search strategy.

2. It is not possible to pick the bottom. Learn how to value companies, practice until you get good, and buy when you find a good business that you understand, with good management, available at a price that has a mathematical expectancy to meet your minimum hurdle rate, for example 20%.

The Long-Term Outlook for Energy

This week Barrons featured an article on ExxonMobile. The article quoted Jeffrey Jacobe, Director of Investments at Fayez Sarofim & Co. The firm is managed by its founder, billionaire investor Fayez Sarofim, who focuses on high-quality dominant large-cap growth companies. Fayez Sarofim & Co. has produced a white paper, written by Jeffrey Jacobe, entitled “The Long-Term Outlook for Energy” which is worth a careful read.

Disclosure: The author owns shares of ExxonMobile.

General Market Indicators Updated

I have updated all four general market valuation indicators found in the upper right column of this blog. In general, according to these indicators, the market appears to be neither over or undervalued.

If the Total Market Cap/GDP indicator – the “Buffett Metric” – is at a 70-80% reading it is thought to indicate that the market is undervalued; it currently stands just under 100%. For more information on this indicator, see the article in Fortune that gives a nice overview.