This is what makes the legendary investor's investing philosophy a WINNER.
Berkshire Hathaway, the holding company managed by legendary investor Warren Buffett, yesterday announced it was, along with a Brazilian private-equity firm, buying American ketchup-maker Heinz for $28 billion.
The deal, the largest ever in the food industry globally, reinforces two things. One, Warren Buffett is still relevant in the investment world despite concerns over how the increased size of Berkshire's portfolio will make it exceedingly difficult for him to continue to deliver the stellar returns it has logged in the past.
And two, what helps him stay relevant is a clutter-free mind and a simple investment logic: the best investment opportunities are found not in the direction everyone is looking, it's often right in front.
At Morningstar, we have long been fans of the Oracle of Omaha and the core of our equity-research philosophy revolves around Buffett's stated principles: look to buy businesses with competitive advantages trading at a discount to what they are worth, and hold for the long term.
Which is why the highlights of our stock analyses are our fair value estimates of a firm; a moat rating, which describes the sustainable advantages (or lack thereof) it has over peers; and a star rating based on the fair value estimate that tells you whether the stock is trading near or away from its fair value.
Here we look into various aspects of the Heinz deal and supplement each with a Buffett quote, signifying how it has Buffett's investing philosophy stamped all over it:
"Buy companies with strong histories of profitability and with a dominant business franchise."
Most of Buffett's notable stock picks, including Heinz, were not firms there were obscure, under-researched or ones that the rest of the market was unaware of (think Coca-Cola, Gilette, GE).
All it needed was to buy businesses with qualities that lend them some competitive advantages over peers and which would compound over time.
"Price is what you pay; value is what you get"
Perhaps one of the most famous but the least-understood of Buffett's quotes, it emphasises upon the importance of understanding what to your eyes is the business' intrinsic worth, without the clamour of noise associated around it.
"The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price," he says.
"Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive."
Buffett has always said that value investing does not mean buying companies that are generally trading at low earnings multiple or price to book but buying companies that are trading at discounts to their real worth.
Buffett has paid top dollar for Heinz: the deal was done at over 20 per cent of its market price despite the fact that the stock was trading at its all-time high, and with its P/E ratio trading at a 15 per cent premium to its historical five-year average.
"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Buffett has separately said that time is the friend of the wonderful business (as such businesses grow over time) and the enemy of the mediocre one. And so he won't mind buying a wonderful company even if it's not at bargain price, as he believes over the long term, earnings growth will take care of the valuation.
The above quote holds truer in the context of the size of Berkshire's portfolio today. He can only buy large companies outright or pick up huge stakes rather than making small stock purchases to produce a sizeable return or "move the needle". And well-entrenched, cash-generating companies often don't come cheap on a valuation basis.
"Our approach is very much profiting from lack of change rather than from change. [For example] with Wrigley chewing gum, it's the lack of change that appeals to me. I don't think it is going to be hurt by the Internet. That's the kind of business I like."
Buffett sticks with predictable, easy-to-understand businesses, which would grow over time. "Heinz is our kind of company with fantastic brand," Buffett told CNBC of the purchase, pointing out to his affinity for buying firms in the Coca Cola mould with strong and sticky brand recognition.
"I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over."
Buffett does not try to chase companies that would produce a dynamic shift in an industry or ones that are expected to be the next great growth opportunity. He instead buys "boring" firms that produce strong cash flows over time. "You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ," he points out.
"We don't get paid for activity, just for being right. As to how long we will wait, we'll wait indefinitely."
Buffett likes to wait when the market does not offer enough opportunities. All of last year, Berkshire had been sitting with excess of $40 billion in cash earning next to nothing in the US's low-yield environment even though he has said he likes to keep only about $20 billion in cash.
For Heinz, Buffett says he had been maintaining a file on the firm since 1980 but moved only when he thought the time was right. "Cash never makes us happy, but it's better to have the money burning a hole in Berkshire's pocket than resting comfortably in someone else's," he once wrote.
"Risk can be greatly reduced by concentrating on only a few holdings."
Contrary to popular wisdom that diversification helps reduce risk, when the right opportunity presents itself, Buffett likes to go "all-in" on his bets, often buying companies outright in or purchasing stakes worth billions of dollars, as diversification tends to reduce overall returns of the portfolio.
"Wide diversification is only required when investors do not understand what they are doing," he says. "Risk comes from not knowing what you're doing."
The Heinz buy symbolises the Buffett way of investing: load up and move in, in a big way once you are confident in your investment thesis.
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