Piggybacking Buffett all the way to the bank

Imagine you were friends with Warren Buffett in 1952. Let’s say you both worked at Graham-Newman in the early 50s. That was the investment firm run by Benjamin Graham, author of the investment classics, Security Analysis and The Intelligent Investor, and the person often called the “father of value investing”. Let’s say you and Warren ate at the local diner and talked about the latest stocks trading at least a third below their net asset value (Graham’s deep value approach). Warren went on to make $50bn. What happened to you? You probably also made a few billion.

If an investor wants to piggyback Buffett, it is worth taking a look at his friends’ portfolios.

First off, there’s the Sequoia Fund, a mutual fund formerly co-managed by the late Bill Ruane, one of Buffett’s buddies from back in the day. When Buffet shut down his hedge fund in 1969, he advised people that, if they wanted a similar approach, they could go into the Sequoia Fund (the fund was so successful that it has been closed to new business since 1982).

I always like to see what Sequoia is buying and selling.

From 1970 until 2006, it returned an annualised 15.6 per cent a year. The fund has stakes in some fascinating companies. For instance, it owns IDEXX Laboratories that, among other things, has a division that develops products to detect contaminated water, and a food diagnostics group that detects various diseases in production animals. The company has 23 per cent earnings growth year on year and a 24 per cent return on equity. While not cheap in the Ben Graham sense, it looks to be growing faster than Wall Street is giving it credit for.

Another company Sequoia owns that is more in the value camp is clothing retailer TJ Maxx. With a $13bn enterprise value and $1.7bn in cash flows, it is trading for just eight times cash flows.

Also, there might be hidden value in its real estate holdings. Analysts expect earnings to rise from $1.63 a share to $1.87 a share over the next year and revenues to go from $17.48bn to $18.82bn. Are analysts generally good at making predictions? For the past four quarters, TJX has met or exceeded Wall Street projections.

Another FoB (Friend of Buffett) to keep track of is Berkshire board member, sometimes bridge partner and charity buddy, Bill Gates. In his efforts to diversify his portfolio from the 10,000 tonne elephant that is Microsoft, Gates often uses what looks like a Buffettesque filter at planning the investments of Cascade Investments, his personal investment vehicle.

While their portfolios don’t overlap much (although both own Berkshire Hathaway stock) there are several qualities in common:
■ A focused portfolio. Cascade has $3.6bn in investments in only 10 holdings. Buffett has long been a proponent of being focused as there are only so many companies at a time you can really study.
■ Very consistent earnings and growth.
■ Boring businesses.
■ Sometimes, good brands.

For instance, about as far away from Microsoft as you can imagine is garbage collector Republic Services. One trend that is probably not tracked as closely as movie receipts is that there is more trash every year than the year before. The company is near five-year highs – but still seems cheap. It has $854m in earnings before interest, taxes, depreciation and amortisation and $7bn in enterprise value (market capitalisation minus net cash). So it has a multiple over cash flows of just 8.5, which puts it in takeover territory.

Another interesting stock in Gates’s portfolio is Fisher Communications, which owns TV and radio stations. Another hedge fund that owns Fisher is Barington Capital. I visited Barington a little over year ago. Their comment to me then, and I don’t know if this has changed since, is that the firm hasn’t had a down investment since 2001. The managers are long-term holders, often
activists, and go for situations that are deeply undervalued. It has been up every year since inception (including 2002 when the market was down 22 per cent and it was up 12.75 per cent) and in 2006 Barington was up 19.11 per cent.

I also like to keep track of Tweedy, Browne’s holdings. When Buffett started accumulating shares of little known microcap company, Berkshire Hathaway, in the 1960s he would call up his buddies at the brokerage firm, Tweedy Browne, to make the purchase. The firm also runs the Tweedy Browne Global Value Fund, which uses the Graham-Dodd style to find stocks to buy. Its fourth quarter 2006 letter to investors says: “While we are still uncovering deeply undervalued equities from time to time and cash reserve levels have receded somewhat in both of our funds, bargains still remain scarce.”

Looking through the holdings, the fund appears to like super-large-cap stocks, with great global brands that are trading at low ratios to cash flows. For instance, it likes Pfizer, which has been hurt by criticism that its pipeline of drugs is lagging and yet, with Pfizer trading at only 11 times forward earnings, there’s plenty of bad news already factored into the price.

When I have a good idea, I tend to call up my friends and talk to them about it. These guys are the same and have been doing it for 50 years. Even if it’s hard to figure out what Buffett is up to, it pays to keep track of what his close associates are doing with their portfolios.

james@formulacapital.com