Who is Warren Buffett’s Mentor?


Recently I have many people asking me about Value Investing. Value Investing has gained much popularity in recent years. There are a lot of courses on value investing courses today. All promising to teach you the skill made famous by Warren Buffett. Over here at Journey With Money, we are unable to commend on courses that we have not attended but we would like to recommend one that the CALM team had attended, which is the Value Investing Bootcamp conducted by Value Investing College.

So in this post, I am just going to take some time to share the history of value investing and the original method which Warren Buffett learned from his mentor called Net-Net Investing.

Father of Value Investing

Everyone is familiar with Warren Buffett as he is one of the richest man in the world. But the real father of value investing was his mentor, Benjamin Graham who first taught him. Of course later on Warren Buffet refined the approach after he met Charlie Munger and place more emphasis on the quality of the businesses rather than the financial numbers.

Benjamin Graham and David Dodd began teaching at Columbia Business School in 1928 and later on co-wrote a book titled Security Analysis in 1934. The approach is using fundamental analysis to analyse stocks that are undervalued. The discount to the stock’s intrinsic value is what Benjamin Graham called the margin of safety. For folks who are less academia, I will strongly encourage you to read the other book which Benjamin Graham himself wrote for the average investor on the street. If you see the front cover of the book- The Intelligent Investor if you will be able to see the words written by Warren Buffett, “By far the best book on investing ever written“. This is quite high praise coming from Warren Buffett, he never said that about any other book.  In today’s context, the book is still pretty relevant and there are many good investing principles we can draw from.

                 

In terms of picking or screening stocks, Benjamin Graham advocates buying companies with steady profits, are trading at low prices to book value, have low price-to-earnings (P/E) ratios, and who have relatively low debt.

What is Net-Net Investing?

“A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.” ~ Warren Buffett

Net-Net Investing which is a strategy used by Benjamin Graham and a lot of people don’t realize this but Warren Buffett, himself used to be a big investor of net-nets.  Warren Buffett got rejected from Harvard Business School. While he was on his way back, he picked up a copy of The Intelligent Investor. After reading the book, it had such a profound influence on his life that he applied to Columbia Business School. He got accepted and the rest is history. That was how Benjamin Graham became his teacher and mentor.

Essentially, the whole idea is to buy a company trading at less than its liquidation value. Ben Graham decided that, if you take a formula: Current assets net out your total liabilities, if it’s greater than the market capitalization (the total number of shares multiplied by share price), the the stock is what you called a net-net or ‘cigar butts’. Usually these would be unloved, troubled companies-firms whose earnings have been shrinking, whose industries are perceived to be in trouble, or whose plans for growth are being questioned. These companies’ shares tumble to the point that they look quite cheap and attractive compared to earnings, sales, cash flow or book value, even if the businesses themselves are not particularly good.

“My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance.

Even then, however, I made a few exceptions to cigar butts, the most important being GEICO. Thanks to a 1951 conversation I had with Lorimer Davidson, a wonderful man who later became CEO of the company, I learned that GEICO was a terrific business and promptly put 65% of my $9,800 net worth into its shares. Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices. Ben Graham had taught me that technique, and it worked.

But a major weakness in this approach gradually became apparent: Cigar-butt investing was scalable only to a point. With large sums, it would never work well.”  ~ Warren Buffett

Basically you could say that Warren Buffett started off with net-net approach which he picked it up from his mentor Benjamin Graham. He was the one that basically taught Buffett what he knew at that time. However over time, Buffet’s fund has grown so much to the extend that he can no longer practise this approach.

Here’s a video for you guys to watch.

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