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Why most people don’t understand Buffett’s style of investing

4 Jun

Buffett rarely invests in small caps, especially not micro small-caps. He did in his earlier days but has now refined his investment philosophy and seeks out businesses with incredibly wide moats. I can’t think of any small cap stocks with wide moats. Next, the reckless thinking that low P/E ratios means the business is so cheap and is a value play. I read one article by a value investor lauding how cheap Garmin was, an ardent Buffett follower. This is the problem, Garmin is not cheap, you miss the forest while you only see the trees. It is not necessarily the case that one should short Garmin, it is the fact that the fundamentals are and continue to worsen. The stock was once north of $110 a share with a market cap exceeding $20 billion.

The business fundamentals are horrible, you are essentially competing with your core offering against a free product from some of the most innovative companies in the world, Apple and Google. Revenues year-on-year have been acknowledged to decline at a worrying rate. The periphery businesses in aviation, healthcare and sports are sketchy and contribute a lower revenue mix although they currently have higher margins. They also require heavier expenditures in research and development. Advertising dollars are going to rise to attract a smaller share of the market compressing margins. It’s almost a perfect storm. There is a reason why Garmin is out-of-favour and it’s not because the business is misunderstood.

Cheap technology plays as value investments, Buffett doesn’t invest in technology-centric companies. He never has and according to what he says he never will. And to be frank he has been spot on in general. The out-of-favour argument – if you take a brief look at Buffett’s holdings they represent some of the premier franchises in the world, few, if any can be described as out-of-favour. His style is to seek out and invest in companies with a wide moat, high barriers to entry, growing positive fundamentals, simple and easy-to-understand models with long-term visibility so few stocks with that combination of characteristics are likely to be out-of-favour. And no penny stocks, please.

Buffett is a legendary investor but he is not a value investor in the purest sense. His style is a witty combination of value and growth so investors who are obsessed following his 1960s approach of cigar-butt gun-slinging investing need to reset their parameters and align themselves with Buffett’s refined methodology. This Buffett ideological misunderstanding is more endemic among the youth, they are blinded by speculative small caps that appear to be cheap by rudimentary metrics while in fact they go against everything that Buffett seeks to teach.

Buffett ain’t in the business of seeking out duds, his long-term investment performance is vastly superior in generating alpha and in comparison to other investment managers. It might look easy but seeking out companies with Buffett orientated metrics is still largely an issue of timing and great intelligence. There are many great businesses but each has a fair price. Capturing it when it is mispriced is what value investing and Buffett-style investing is about.

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