How Warren Buffett Used “Scuttlebutt” to Invest in Apple and American Express
This article was originally published on MastersInvest.com .
Charlie Munger loves the concept of simplicity.
When it comes to investing it’s important to understand what a company does and what the key factors are that will determine the company’s success. You don’t need a 2,000 line spreadsheet to determine if an investment is likely to be successful. But you do need to think. Talking to people involved in the industry and with the product can provide a huge edge.
In Berkshire Hathaway’s 1997 annual letter , there’s a great snippet where Warren Buffett details how he came about building a significant position in Amex. Buffett had purchased $300m of American Express hybrids in a private placement in 1991. The hybrids were due to convert to common stock in 1994 and in the month before Buffett had been mulling over whether to sell upon conversion. While he thought the CEO was outstanding and likely to maximise whatever Amex’s potential was, he was leaning toward a sale, as the company faced relentless competition from a multitude of card issuers, led by Visa. Buffett continues:
We now have a $3 billion gain in our Amex shares, and I naturally feel very grateful to Frank. But George Gillespie, our mutual friend, says that I am confused about where my gratitude should go. After all, he points out, it was he who arranged the game and assigned me to Frank’s foursome.”
In a recent CNBC interview , Buffett explained some of the analysis he undertook when he bought Berkshire’s $17b stake in Apple:
It had an effect on me. I went out to meet Phil Fisher after reading the book, I found him in this little office in San Francisco. And I recommend any investor read that book. And it’s still in print. And he talks about something called the scuttlebutt method , which made a big impression on me at the time. But I used it a lot, which is essentially going out and finding out as much as you can about how people feel about the products that they … it’s just asking questions, basically.
And Apple strikes me as having quite a sticky product and enormously useful product that people would use , and not that I do. Tim Cook’s always kidding me about that. But it’s a decision-based … but again, it gets down to the future earning power of Apple when you get right down to it. And I think Tim has done a terrific job, I think he’s been very intelligent about capital deployment. And I don’t know what goes on inside their research labs or anything of the sort. I do know what goes on in their customers’ minds because I spend a lot of time talking to ’em.”
Buffett expands on the scuttlebutt process:
So I ask people about products all the time . When I take my great-grandchildren to Dairy Queen they bring along friends sometimes. They’ve all got a iPhone and, you know, I ask ’em what they do with it and how … whether they could live without it, and when they trade it in what they’re gonna do with it . And of course, I see when they come to the furniture mart that people have this incredible stickiness of — with the product. I mean, if they bring in an iPhone, they buy a new iPhone. I mean, they’re … it just has that quality. It gets built into their lives. Now, that doesn’t mean something can’t come along that will disrupt it. But the continuity of the product is huge , and the degree to which their lives centre around it is huge . And it’s a pretty nice, it’s a pretty nice franchise to have with a consumer product.”
And on the Apple products:
Buffett reminded us of the need for simplicity in his 1994 letter:
Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring , the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.”
While Buffett no doubt analysed Apple’s historical financial statements , he recognised that it is Apple’s future earnings power that will determine the success or failure of the investment. A key factor that will determine that future earnings power is the strength and sustainability of the consumer product franchise. Here, observing, speaking to, and thinking about the company’s products and customers can provide an edge. Understanding the qualitative factors can be more important than the historical numbers. Keep it simple, it’s not rocket science.
Common Stocks and Uncommon Profits and Other Writings
by Philip Fisher
“I sought out Phil Fisher after reading his Common Stocks and Uncommon Profits…A thorough understanding of the business, obtained by using Phil’s techniques…enables one to make intelligent investment commitments.” —Warren Buffet
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Using the letters Warren Buffett wrote to his partners between 1956 and 1970, veteran financial advisor Jeremy Miller presents the renowned guru’s “ground rules” for investing—guidelines that remain startlingly relevant today.
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