Valuation-based screening is a pillar of most fund managers’ investment approach, highlighting interesting ‘value’ stocks worthy of further analysis. The academic research would appear to concur. In this article, we contrast this approach with that of Warren Buffett. His process is very unusual and, in this information-laden world, is very difficult to follow. Serious investors should give it serious consideration.
In a 2007 interview with Warren Buffett, Liz Clayman of the Fox Business Network asked:
“How did it come to your attention, how do you find a stock like PetroChina Company Limited (ADR) (NYSE:PTR) (HKG:0857)?”
Buffett: “I sat there in my office and I read an annual report, which was fortunately in English, and it described a very good company. And it told about the oil reserves, told about the refining, told about chemicals and everything else and I sat there and read and I said to myself this company is worth about $100bn.
Now I didn’t look at the price first – I look at the business first and try and figure out what it’s worth because if I look at the price first I get influenced by that.
So I look at the company first, I try to value it and then I look at the price and if the price is way less than what I just valued it at I’m going to buy it.”
Clayman’s question referred to Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s purchase of a stake in PetroChina Company Limited (ADR) (NYSE:PTR) (HKG:0857) around 2002/03. At the time of purchase, the market capitalisation of PetroChina was $20 billion, circa one-?fifth of Buffett’s own estimate of intrinsic value.
Less than four years later, Buffett sold Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s stake for $3.5 billion, a handsome return on the roughly $500 million cost of the investment. [The more than doubling of the oil price in the meantime increased his estimate of fair value.]
However, more important than the investment outcome, I believe, is Buffett’s approach to business valuation, telling us that he valued it without reference to the stock market price.