Investing Based on Your Own Analysis
At the 2003 Berkshire Hathaway (BRK.A, BRK.B) shareholder meeting, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) were asked how they spend their time when analyzing investments. Buffett answered with the following:
"We read a lot. We read daily publications, we read weekly or monthly periodicals, we read annual reports, 10-K's, 10-Q's. Fortunately, the investment business is a business where knowledge cumulates. Everything you learn when you're 20 or 30 - you may tweak some as you go along - but it all kind of builds into a knowledge base that's useful forever. I read a lot of 10-Ks, a lot of annual reports. 40 or 50 years ago I did a lot of talking to managements. I used to go out and take a trip every now and then and drop in on 15 or 20 companies. I haven't done that for a long, long time. Everything we do, pretty much, I find through public documents. When I made an offer for Clayton Homes, I'd never visited the business. I'd never met the people. I did it over the phone. I'd read Jim Clayton's book. I looked at the 10-Ks. I knew every company in the industry. I look at competitors. And I try to understand the business and not have any preconceived notions. And there is adequate information out there to evaluate a great many businesses.
We do not find it particularly helpful to talk to management. Managements frequently want to come to Omaha and talk to me, and they usually have a variety of reasons that they say they want to talk to me, but what they're really hoping is we get interested in their stock. That never works. Managements are not the best reporting parties in most cases. The figures tell us more than management does. So, we do not spend any real amount of time talking to management. When we buy a business, we look at the record to determine what the management's like, and then we want to size them up, personally, as I said earlier, whether they will keep working. But we don't give a hoot about anybody's projections. We don't even want to hear about them. In terms of what they're going to do in the future, we've never found any value in anything like that. But just a general business knowledge, what we've seen work, what we've seen has not worked. There's a lot you absorb over time...
You want to read lots of financial material as it comes along... You really want to have a database in your mind so that you can tell what kind of a business you're looking at, in general, by looking at the figures. We never look at any analyst reports. If I read one it was because the funny papers weren't available. I don't understand why people do it..."
This advice really hit home for me when I recently did some research on Fastenal (FAST). As I read through the 2018 annual report and the Investor Day transcript, I felt that I had a good grasp on the historic financial results that had been generated by the business, as well as the competitive advantages that had enabled the company to deliver those strong numbers for decades. In addition, I felt I had a good appreciation for the strategic decisions management was making in the business, as well as why I thought those decisions would likely work out well over the long run.
When I concluded that exercise, my first instinct was to go dig through some analyst reports, but then I stopped to think for a second: why? What was I looking for from analysts that I had not already uncovered from the primary research I completed on Fastenal? If I couldn't assess the business and the management team based on the work I had already done, why would I want to start relying on the conclusions others had reached on the company and its future?
As I've taken some time to think about it, here are my thoughts. Generally speaking, analyst reports provide commentary on short-term business trends. They explain why a stock went up or down after earnings (i.e. how the actual results compared to consensus expectations), and usually include some commentary on what the analyst expects in the coming quarters.
And while that information may be helpful for some market participants, I don't think it adds much value for the long-term investor. In fact, I'd go so far as to say that much of what you read in the average analyst report is irrelevant to the task at hand for a true business owner. If you're going to own a stock for five or ten years, what happens over the next six to twelve months should not be a deal breaker. In the same sense, if you bought a local coffee shop, you wouldn't get jittery and look to sell it a month later if the results were slightly below your expectations.
Just as importantly, I think an obsessive focus on quarterly results can draw your attention away from what truly matters. It also begs the question: if your assessment of the sustainable competitive advantages that enable a business to generate outsized returns come into question based on just a few months of business results, how solid can the foundation of your investment thesis truly be?
Like most things in life, investing isn't black or white. I'm not saying to cover your ears and avoid quarterly results or the thoughts of other well-informed market participants. What I am saying is that what happens in the short-term is some combination of signal and noise, and it is very difficult to distinguish between the two in real time. Your assessment of the historic results of the business over years - or even decades - is the signal. It's a key component when forming the rationale of a long-term investment. Recent quarterly results and stock price movements should not hold nearly the same weight. Put differently, if you assess a business and conclude it deserves to be a long-term holding in your portfolio, that really shouldn't change a few months after you initiate the position.
Conclusion
I was speaking with my friend Bill Brewster about this, and I think he made a great point:
"One of my favorite things about Buffett is how he just writes the check. Then, I honestly don't think he looks much because he's already underwritten the path of outcomes. I suspect he will adjust if there are really meaningful changes but, generally speaking, I think he looks at the world so probabilistically that he just figures 'yeah, this is one of the potential paths.'"
I think that sentiment was reiterated by Buffett himself, who said the following when he was recently asked how closely he tracks the short-term developments for Apple (AAPL), his largest position: "If you have to closely follow a company you shouldn't own it."
Some people took Buffett's comment as flippant or even disingenuous, but I honestly think that's how he views equity ownership. When he buys a stock, he views it no differently than buying the entire business. Just like when he buys 100% of a company, his intention when he invests is to be an owner for a long, long time.
While this approach may cause you to underreact at times when the short-term data moves against you, I also think it puts you in a position to maintain the proper mindset when others are making split-second portfolio decisions based on a single quarter of business results. Personally, I'm willing to risk the former to avoid the latter.
I think this version of "buy and hold" is an intelligent way to approach the investment process, particularly in a world where so many people are playing an entirely different game due to their obsessive focus with short-term results.
Disclosure: Long BRK.B
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