Lyrical Investing Perspectives from Warren E. Buffett
"SHARES ARE NOT MERE PIECES OF PAPER. THEY REPRESENT PART OWNERSHIP OF A BUSINESS. SO, WHEN CONTEMPLATING AN INVESTMENT, THINK LIKE A PROSPECTIVE OWNER." – WARREN BUFFETT
With the recent news that Warren Buffett will be stepping down from his position as CEO of Berkshire Hathaway, we wrote this piece to illustrate how his teachings have influenced us as investors. While Lyrical’s approach of investing in the “gems amid the junk” is homegrown, our philosophy and process has been influenced by great investors that came before us. And there is none greater than the Oracle of Omaha, Warren Buffett.
The investment community is blessed with a treasure chest that includes nearly 70 years of writings and commentary from Buffett. In each section below, we match a key pillar of Lyrical’s investment process with one of his influential quotes.
VALUE
“Price is what you pay; value is what you get.”
Throughout our careers we have owned hundreds of cheap stocks. We always start with price. Even when the future earnings deliver as expected, if the purchase price is too high, the investment outcome will disappoint. Price matters most.
Price also does not drive success. What has separated the winners from the losers in our history was the future earnings of the companies (i.e. what we got). When the future earnings were within our large margin of safety, the stocks were eventually successful. However, when the future earnings significantly underachieved beyond our margin of safety, valuation was not enough. Thus, the key to investment success is not just the price we pay but also making sure we get close enough to the earnings we expect.
QUALITY
“Whether we’re talking about stocks or socks, I like buying quality merchandise when it’s marked down.”
In our experience, our earnings models were more likely to be correct when we avoided the lowest quality companies. Good companies have been easier to get right than bad companies. Thus, we have a minimum ROIC threshold that all our companies must exceed. If a company does not exceed this threshold, we will not own it, no matter how cheap the stock appears. Some of the lower quality areas that we routinely avoid include commodities, deep cyclicals, and utilities.
ANALYZABILITY
“You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
In our experience, our earnings models were more likely to be correct when we analyzed companies with straightforward business models and transparent financials. The reliability of our earnings models improves significantly when we focus on businesses that are less complex and more readily understood, rather than those with opaque financial structures or highly intricate operations. There are no style points in investing, and you do not get awarded extra return just because a company is excessively complicated or is in the middle of turmoil. We have a strong investment team that performs deep research and analysis on every investment, working to get the earnings right. But perhaps as important as that is we target stocks that are more analyzable, and therefore easier to get right. These easier-to-understand stocks are harder to find but are more likely to have a successful outcome. Some of the low analyzability areas that we routinely avoid include banks, pharma and biotech, and companies experiencing disruption like store-based retailers.
PATIENCE
“The stock market is a device for transferring money from the impatient to the patient.”
Investing in good, simple companies at cheap prices should be a formula for success. Often, the stock market will recognize the value in our stocks on a timely basis, but it is also common for it to take many years, testing the patience of our team and our clients. What enables our ability to be more patient than others is our focus on earnings results over stock prices. A core tenet of our belief is that if we get the earnings right, eventually we’ll get the stock right.
TIME HORIZON
“In the short run, the market is a voting machine but in the long run it is a weighing machine."
Finding the gems amid the junk is challenging. While good companies with good growth profiles can be found in the cheapest quintile, they are still very rare. Our competitive edge for finding these gems is our long-term orientation. Gems typically do not have an identifiable catalyst to unlock value quickly and are skipped over by most investors. We do not need a catalyst in our approach. If the company can grow its earnings as fast or faster than the market, then it should produce a market rate of return without any multiple expansion. Then, someday, sooner or later, the market should reward a company with market-like growth with a market-like valuation, creating outperformance regardless of the amount of time it takes. Sooner is obviously preferred over later, but both would result in a successful outcome.
RISK
“Risk to us is the risk of permanent loss of capital, or the risk of inadequate return.”
We invest in equities to meet our long-term investment objectives. Thus, risk to us is the probability of not meeting those objectives, and volatility is not a good proxy for that risk. For example, cash has almost no volatility, but it also typically has a yield below inflation, producing a negative real return over time. Thus, from a volatility perspective cash has zero risk, but for long-term investment objectives it may be the riskiest asset you could hold.
We specialize in owning companies that are misunderstood or ignored by the market. As a result, the prices of these stocks can fluctuate significantly more than the underlying earnings of the business. When we think about risk, we look past stock price volatility to the volatility of the earnings. It is the compounding of earnings growth that will be most responsible for meeting our long-term objectives, not the daily fluctuations of the stock price.
INCENTIVES
“We eat our own cooking.”
If you read Buffett’s letters all the way back to 1959, you’ll find a common thread discussing the power of incentives. Buffett’s long-time partner, the late Charlie Munger said, in his famously succinct manner, “show me the incentive and I’ll show you the outcome.” There is no better incentive than skin in the game. Each senior member of the investment team has most of their investable assets invested in Lyrical portfolios. We want to maximize long-term returns for our partners and we are fully invested right beside them.
Past performance is not necessarily indicative of future results. There is no guaranty that the investment objective of our strategies will be achieved. For a discussion of the risks of an investment please see lyricalam.com/notes-disclaimers.