There is no such thing as a self-made woman or man. Everyone stands on someone else’s shoulders. Lucky people find worthy teachers. (Or the teachers find them, as the saying goes in spiritual circles.) Warren Buffett’s first mentor was the renowned investor Benjamin Graham who wrote The Intelligent Investor.
Graham, a natural pessimist, spent his days probing Moody’s Manuals in his search for mis-priced companies. He hunted for losers, the cigar butts of the equity world that had been kicked to the curb. Wisely, Graham suspected that some of these stocks had been discarded a tad prematurely. Sure, they weren’t pretty, all mashed up by the side of the road, but some of them had one last puff left in them. His talent was to find these unfortunates and suck out that last puff before tossing them away for good.
Graham’s carrion-like investment style made a strong impression on Buffett who developed a habit of buying distressed companies in the hopes of turning them around. (Textile firm Berkshire Hathaway is one example of Buffett’s several failed efforts.)
That is, until he met Herb Wolf.
Wolf was a New York-based investor and he showed Buffett there was another way to make money. Instead of profiting from dying companies, one could profit from the living. As Buffett recounts in Snowball, “Herb said to me, ‘Warren, if you’re looking for a gold needle in a haystack of gold, it’s not better to find the gold needle.'”
Treasure hunting is an easy trap for both novice and experienced investors. The more obscure the investment, we believe, the better.
Give someone the opportunity to invest in 100 shares of Royal Dutch Shell, a company with good liquidity, a low P/E and a high yield, or a hush-hush-by-invitation-only venture capital startup, and people will trip over each other to make out cheques to the latter.
An investment in Royal Dutch Shell is the bird in the hand—a solid company that ain’t goin’ nowhere. And, it’s also the bird in the bush—perpetual dividends and capital appreciation. It’s possible that the venture investment will generate higher returns than this blue chip. It’s equally likely that it will vaporize. No bird in hand. No bird in bush. Bye-bye birdie.
Like Buffett version 1.0, I enjoy treasure hunting now and again but I limit it to less that two percent of my portfolio. Over the years I’ve shifted to Buffett version 2.0:
- Buy winners, not losers
- Avoid overpriced stocks and high transaction costs to keep a margin of safety
- Go long
Then sit back, sip an iced tea and listen to the sweet birds sing.
Happy Canada Day!