Over the years, I have been most significantly influenced by the writings of Warren Buffet. (Fortunately, I have been a shareholder of Berkshire Hathaway since 1977). Warren was a student of Ben Graham at Columbia where he learned the important balance sheet value method of investing. Every company has a value determined by its balance sheet, and you buy a stock when it’s selling for $.50 on the balance sheet dollar and sell it at $.80. Buffet has taken the balance sheet value as a starting point and gone on to identify “really good business” as the place to focus. These businesses are ultimately identified by their extremely high returns on assets and capital. When these high returns appear, Buffett contends an economic royalty of some kind exists, and the “value” of the business is much greater than the balance sheet reveals. Buffett has detailed the many common attributes of these companies, and a few of them are as follows:
- They see their profits in cash.
- They are not natural targets of competition.
- They have freedom to price their products.
- They are understandable.
- They do not take a genius to run.
- They earn very high returns on capital and assets.
I am in the Buffett “camp” and accordingly try to find companies that fit these criteria. One very important benefit of these companies is that neither poor managerial decisions, nor adverse economic environments will upset the apple cart for too long. That is, their business franchise will prevail in the long run. Our resulting style in the partnership is to try and find outstanding businesses, to understand their true value, and when the price is reasonable, purchase shares. Occasionally, the market will allow an opportunity to buy the shares at a real bargain price and once every few years at a “steal.” The whole purpose of course in pursuing superb businesses is to achieve superior investment results. I believe that this is the most compelling route to achieve such results! It is a route that is magnificent in its simplicity and accordingly has some chance of leading us to success.
In addition to focusing on these superior businesses, Buffett also promulgated two rules for investing to which we try to adhere. They are:
- Rule #l- Don’t lose money.
- Rule #2- Don’t forget the first rule!
The practice of not losing money is significantly advanced by the selection of superior businesses, because as we just pointed out, their royalty keeps on working in spite of general business conditions and isolated poor managerial decisions. In the case of the former, however, the market may offer up the shares at a true bargain price. In following the Buffett principles to their logical conclusion, I leave defined Nirvana in investing as finding a company with the following characteristics:
- It is a superior business.
- It is exceptionally well-managed.
- The managers reinvest the naturally occurring excess capital as well as they run the business enterprise.
Our motto in investing is “happiness comes from small improvements.” We try to find great companies to invest in which will do well in nearly all environments. And when we buy shares in them, we do not fuss with them because we believe that they will improve and grow in value and that as time passes, that improvement in value will be reflected in the stock price. The fewer investment decisions we make, the less exposure we have to making mistakes. Obviously, these decisions that are made must be correct, which is why we spend so much time trying to understand the quality of businesses.
I reread this letter for the first time in many years after my partner, Chris Cerrone, recently reminded me of its contents. This approach has been responsible for the investment outcomes of the subsequent 26 years. We spend our time at Akre Capital Management trying to improve each element of our investment approach which, some time after this letter was written, we began referring to as our “three-legged stool”: business model; talented and honest management; and an outstanding thought process and execution in the reinvestment of free cash flow.
Some things are timeless and meant to be!