As a value investor it is important that you read every word of every letter ever written by Warren Buffett in his Berkshire Hathaway Shareholder Letters.
One great example of what you can learn comes from his 1985 Chairman’s letter in which he discusses his intrinsic value calculation of The Washington Post and how he turned $10.6 million into $221 million while others were following the herd and embracing the efficient market theory. It’s also important to note that the year after Buffett’s investment, the market value of The Washington Post sank to $8 million, but Buffet remained unperturbed.
Here’s an excerpt from that letter:
We mentioned earlier that in the past decade the investment environment has changed from one in which great businesses were totally unappreciated to one in which they are appropriately recognized. The Washington Post Company (“WPC”) provides an excellent example.
We bought all of our WPC holdings in mid-1973 at a price of not more than one-fourth of the then per-share business value of the enterprise. Calculating the price/value ratio required no unusual insights. Most security analysts, media brokers, and media executives would have estimated WPC’s intrinsic business value at $400 to $500 million just as we did. And its $100 million stock market valuation was published daily for all to see. Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.
Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value – and even thought, itself – were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest – whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)
Through 1973 and 1974, WPC continued to do fine as a business, and intrinsic value grew. Nevertheless, by year end 1974 our WPC holding showed a loss of about 25%, with market value at $8 million against our cost of $10.6 million. What we had thought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to well below 20 cents on the dollar of intrinsic value.
You know the happy outcome. Kay Graham, CEO of WPC, had the brains and courage to repurchase large quantities of stock for the company at those bargain prices, as well as the managerial skills necessary to dramatically increase business values. Meanwhile, investors began to recognize the exceptional economics of the business and the stock price moved closer to underlying value. Thus, we experienced a triple dip: the company’s business value soared upward, per-share business value increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value.
We hold all of the WPC shares we bought in 1973, except for those sold back to the company in 1985’s proportionate redemption. Proceeds from the redemption plus year end market value of our holdings total $221 million.
If we had invested our $10.6 million in any of a half-dozen media companies that were investment favorites in mid-1973, the value of our holdings at year end would have been in the area of $40 – $60 million. Our gain would have far exceeded the gain in the general market, an outcome reflecting the exceptional economics of the media business. The extra $160 million or so we gained through ownership of WPC came, in very large part, from the superior nature of the managerial decisions made by Kay as compared to those made by managers of most media companies. Her stunning business success has in large part gone unreported but among Berkshire shareholders it should not go unappreciated.
Our Capital Cities purchase, described in the next section, required me to leave the WPC Board early in 1986. But we intend to hold indefinitely whatever WPC stock FCC rules allow us to.
We expect WPC’s business values to grow at a reasonable rate, and we know that management is both able and shareholder-oriented. However, the market now values the company at over $1.8 billion, and there is no way that the value can progress from that level at a rate anywhere close to the rate possible when the company’s valuation was only $100 million. Because market prices have also been bid up for our other holdings, we face the same vastly reduced potential throughout our portfolio.
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