The Real Reason Warren Buffett Is A Billionaire

Warren Buffett's net worth skyrocketed from a few million to over a billion after he drastically changed his investing strategy. A strategy he learned from an investor that most people have never even heard of. In the early 60s, Warren Buffett took a flight to San Francisco and met that very investor. His name was Philip Arthur Fisher. I met Phil Fisher just once and it was great. I enjoyed it. I loved it. They were such good writers and their thoughts were so clear. It's proved to be an obviously good idea, yet 98% of the investing world doesn't follow it. Phil Fisher has one of the greatest investing track records of all time and his teachings reached Buffett at exactly the moment he needed them. Principles that guided investments in American Express and The Washington Post and, well, practically every stock pick since then. The stories from this part of Buffett's career are fascinating and they're sprinkled with investing lessons for those trying to find success in the stock market. Plus, I'm going to show you some tools that make it easier than ever to apply them in your own portfolio. This video was made in partnership with Stockopedia. More on them later in the video. The shift in Warren Buffett's stock picking strategy wasn't really a choice, but rather came out of necessity. Ben Graham's cigar butt strategy had made Buffett a millionaire by age 30, however it didn't scale very well and was undermining his reputation. Graham's approach was simple. Buy businesses so cheap you're effectively paying less than the cash, inventory, or liquidation value on the balance sheet. Graham called them net nets in his book The Intelligent Investor, but Buffett likened them to cigar butts you find on the sidewalk. You get one free puff and then move on to the next stock. Do this over and over again and you'll make a tidy profit. Early on, Buffett would scour all corners of the market to find these tiny companies being ignored by Wall Street. Today, you could pull up every stock in the world that fits the formula in about two seconds on Stockopedia, but back in the 1950s this meant going one by one using a physical Moody's manual. In 1950, at the age of 20, he invested in the Commonwealth Trust Company. The bank had $125 per share in assets, but was trading for just $50 per share. Less than a year later, he sold the stock for a 50% gain. But as Buffett's wealth grew, these cigar butt puffs weren't big enough. He needed to invest bigger amounts of money without buying so much the company that he would cause the price to move. So to make the strategy work, he sometimes had to take control of the company. That's where the reputational problems started to creep in. In the late 50s, Buffett's investment partnership took control of Dempster Mill Manufacturing Company. To prevent its bankruptcy and make a profit, he swapped out the manager and cut costs aggressively by laying off around 100 employees. From his perspective, he had just saved a dying company, but the townspeople of Beatrice saw him as a ruthless owner who just came in and gutted it. But there's another disastrous cigar butt investment that became the foundation for an entirely new strategy. Berkshire Hathaway. We know it today as Buffett's empire of American companies and stocks. But in the early 1960s, it was just a struggling textile business. With some historical data shared by Stockopedia, we can see that while Berkshire was profitable in 1960, they began bleeding cash, and it was only getting worse. Buffett didn't care about this. The value he saw was in the assets. The cash, inventories, the land, buildings, and mills were worth about $19 per share after paying the company's debts. And yet, the stock price was just $7.50. So the Buffett partnership bought about 5% of the shares between 1962 and 1964. His idea was that Berkshire would buy back his shares for a profit as they shut down and liquidated plants. Berkshire's CEO initially agreed to pay $11.50 per share, but when the tender offer came in, it was slightly less. A trivial difference, but Buffett felt disrespected. So instead of selling, he bought every share he could until he owned a controlling interest. The good news was that he'd paid slightly less than the per share value of the company's net assets. The bad news, however, was he now had his capital trapped inside a dying business. To make matters worse, the stock market was booming, so the cigar-butt, ultra-cheap stock opportunities were drying up. Fortunately, two very important things happened around this time. Firstly, back in 1959, he met Charlie Munger, the man Buffett credits for pushing him away from cheap garbage stocks and towards a completely new strategy, and who would join Buffett at Berkshire two decades later in 1978. But secondly, he came across a book called Common Stocks and Uncommon Profits by a man named Philip A. Fisher. Well, actually it was fellow investor Bill Ruan who introduced him to the book in the late 50s. It detailed Phil Fisher's investing approach, including his now-famous scuttlebutt method for identifying stocks with enormous growth potential in front of them. The approach was markedly different from the strict value focus Buffett had been used to, but the teachings were crystal clear and made perfect sense. He delved deeper into Fisher's history. He'd attended Stanford Business School, including a field study course that involved visiting local companies. Fisher drove his professor every day, to get extra one-on-one time to talk business. Phil would later recall that the mentoring and the real-life experiences ultimately planted the seeds for his strategy. His Wall Street career had started just a year before the 1929 stock market crash, and he vowed to avoid the mistakes that many people had made. Three years into the Great Depression, he started Fisher & Co, where he advised the general public on a concentrated basket of growth stocks he had analysed. After a three-year hiatus to serve in World War II, he resumed providing investment advice, now focusing on just a handful of clients. By scaling back to less than 15 clients, he was able to use performance-based fee contracts. His clients stayed with him for years, because his method was delivering them huge profits. Then, in 1958, after beating the market for years, he wrote the first of four investing books. The book laid out a 15-point criteria for picking stocks. Each characteristic can be partially assessed through the company's financial statements, but the true picture would come from interviewing suppliers and customers, talking with management, or even ex-employees and its competitors. For example, point seven on the checklist is outstanding labour and personnel relations. Fisher had found that great companies often had low turnover and a motivated workforce, so he favours companies that offered fair compensation, advancement opportunities, and a culture of loyalty. To assess this point, you could compare compensation between similar businesses, but you would learn far more by talking directly with employees. Companies love to boast their superior workplace cultures in marketing materials, but what is it actually like in practice? Fisher called this investigative groundwork the scuttlebutt method. A scuttlebutt was a water tank on sailing ships, so basically the equivalent of the water cooler in an office. The place to hear gossip about the true nature of the business. This method was one that Fisher used throughout his entire career. There was a company called Food Machinery, whose stock price fell from $21.50 in 1929 to just $4 by 1932. It was a pretty small company at the time, doing about $5 million in sales a year, which is about $100 million in today's dollars. Despite the pessimism from Wall Street, it met many of his 15 key points. It had sizeable market potential, with the demand for canned food likely to surge when the Great Depression ended. It was developing new products by diversifying into chemicals, and it had top-notch management and engineers, which Fisher was able to test by meeting with the company's leadership. Particularly, John D. Crummey, who was the president and the founder's son-in-law. Fisher concluded that the firm's intrinsic value far exceeded its current modest earnings, and so he invested. Just two years later, in 1935, the stock was trading at $30 a share. Another two years later, it was up to $50 a share. 90 years later, the company does $4 billion a year in sales, almost a thousand times more than when Fisher was buying. Buffett visited Fisher at his office in San Mateo, California. I met Phil Fisher just once, and it was great. I enjoyed it. I loved it. He was nice to me. But because Fisher was such a good writer, everything he learned was straight out of his literature. And in 1963, Buffett first began applying this new strategy in a big way. That year, American Express saw its stock price fall almost 50% because of the salad oil scandal. If a bank wanted to lend money to a small business, American Express would go out to the business's warehouses and verify how much inventory they had. That inventory would then be the collateral against the loan in case the business failed. Well, in the early 60s, a guy named Anthony DeAngelis lied about how much oil he had in warehouse tanks in order to get loans. He filled the tanks with water instead of oil, and the Amex auditors didn't pick up on this. When the fraud was exposed, American Express was on the hook for about $60 million, which is about $600 million in today's dollars. Buffett saw an opportunity to invest in a great company that was simply suffering from a one-time disaster. He used the scuttlebud method to see if the general public had lost trust in the Amex brand. To quote Fortune, Buffett concluded that while Wall Street had punished Amex by battering the stock price, Amex's reputation hadn't been tarnished on Main Street. Buffett bought 5% of the company for about $20 million, and later built a 22% ownership stake that's worth $50 billion today. In 1966, Buffett invested $4 million into The Walt Disney Company. Before investing, he went to meet with Walt Disney himself in person. Another clear case of Buffett using Phil Fisher's principles, only this time he made a mistake. Buffett sold the investment for just a modest profit. If he'd held onto that investment like he did with American Express, he would have turned $4 million into about $10 billion. Even by the late 60s, Buffett's head was still primarily in cigar-butt, deep value mode. There's a quote from him in a 1969 Forbes piece where he says, I'm about 15% Phil Fisher and 85% Benjamin Graham. He'd always keep some of Ben Graham's principles, like margin of safety, but as time went on, Buffett lent more and more into Fisher's ideas. That same year, Buffett dissolved the investment partnership and rolled his personal wealth into Berkshire Hathaway. The textile business was failing, but he could use it as an investment vehicle. In 1972, Berkshire acquired See's Candy for about $25 million. Its confectionery brands are so strong that they've been able to raise prices for decades. Another key principle of Fisher's, look for pricing power. The next year, Buffett set his eyes on The Washington Post. The newspaper company had gone public in 1971 at $26 a share, but starting in 1973, the stock market collapsed nearly 50%. Interest rates were high, there was an OPEC oil embargo, and of course the Nixon-Watergate scandal. The Washington Post stock fell to about $20 by mid-1973, despite the business remaining fundamentally sound. Again, thanks to Stockopedia, we can see that The Washington Post's profit margins remained fairly stable, and so did the return on equity, never dipping below 10%. Buffett invested $10 million at a share price of about $20, at a time where he believed the stock was worth at least $100 per share. A decade later, in 1985, his stake was worth more than $200 million. Buffett was now executing the best of both Benjamin Graham and Phil Fisher's principles. Quality merchandise when it's marked down. Now we get to the fun stuff. How can we adopt some of these principles in our own investment portfolios? Well, thanks to the internet, it's relatively easy. There's a ton of different stock screeners out there, but the only one I use these days comes from Stockopedia. And this is why. I go to the browse tab, pick an investing style, and I can see the different stock screeners based on the investing criteria of successful investors. One of them of course is Phil Fisher, and within a few seconds I've filtered more than 60,000 stocks, down to a few hundred that fit his investing style. The American stocks in this particular basket have returned about 230% in the past 5 years, compared to about 90% from the index. If I want to use this screener as a starting point, I can copy it and add some of my own filters, or just create one from scratch. You can have a quick sneak peek at the ultra-conservative screener that I use from time to time. Each company has a Stockopedia stock rank, of quality, value, and momentum, that stems from the principles used by investment legends like Buffett and Fisher, and is grounded in decades of academic research. A lot of the quantitative analysis from Fisher's checklist can be done in Stockopedia too. Profit margins, return on capital, and valuation for example. And this forms the springboard for you to do further qualitative analysis per Fisher's Scuttlebutt method. Reading reviews from customers and employees, watching interviews from the company's leadership. Even these Scuttlebutt strategies can be done online nowadays. I've really only just scratched the surface in this video, but the team at Stockopedia has put together a free resource that outlines Warren Buffett's investing blueprint, that combines the best of Benjamin Graham, Charlie Munger, and Phil Fisher. As well as 20 examples of high quality companies that exemplify Buffett's principles today. The link to this free resource is down in the description below, and there's also an exclusive offer if you're interested in checking out Stockopedia, including a 14-day free trial, so you've got nothing to lose giving it a try. Thanks for watching.