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Last Updated : Nov 28, 2019 03:24 PM IST | Source: Moneycontrol.com

Double Your Income series: What you can learn from the world’s richest investor

There's no doubt that Coke has played a stellar role in Buffett's rise as one of the best investors in the world. But as per Buffett himself, his big aha moment came after his investment in a much smaller company.

Rahul Shah @moneycontrolcom

A lot of investors think Warren Buffett's milestone investment was his purchase of Coke.

There's no doubt that Coke has played a stellar role in Buffett's rise as one of the best investors in the world.

But as per Buffett himself, his big aha moment came after his investment in a much smaller company. It was See’s Candies that presented him with a life altering insight.

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Here's him.

We have made a lot more money out of See’s than shows from the earnings of See’s, just by the fact that it’s educated me. If we hadn’t bought See’s, we wouldn’t have bought Coke. So thank See’s for the $12 billion. We had the luck to buy the whole business and that taught us a whole lot.

If Buffett wouldn’t have bought See’s Candies first, we would have perhaps never bought Coke.

But what’s so special about See’s. Why did Buffett go ga-ga over this investment of his?

Well, simply because no business comes closer to being called a dream business than See’s Candies. When Buffett bought See’s in 1972, it was earning $5 m in pre-tax profits on $8 m of capital.

What was the situation in 2007? Pre-tax profits had gone up to $82 m.

And here comes the shocking part. The capital invested in the business went up from $8 m to a mere $40 m.

Yes, you read that right. No zeroes missing here.

So, in 35 years, the company earned an extra $1.35 bn in profits by investing a mere $32 m in incremental capital.

No wonder Buffett calls See’s his dream business.

Well, this is going to be my endeavor as well in my Double Income Project. I will attempt to find See’s Candies kind of businesses at valuations which incorporate an adequate margin of safety.

Yes, I am going to look for stocks that are huge cash generators. Stocks where the underlying business is mostly self-sufficient when it comes to funding growth.

They should generate enough cash so as to fund their entire growth without resorting to borrowings.

This is going to be my number one criterion for recommending a stock in Double Income. If the stock does not pass this test, I will most likely give it a miss.

If it does pass the test, it will be subjected to other parameters. I am talking about things like competitive advantage, management quality, and margin of safety in valuations.

So, for the stock component of my Double Income Map, I am going to recommend an allocation of maximum 60 percent and a minimum of 25 percent.

The group of stocks that will find their way into the service will of course be strong cash generators. The plan is to not have more than 4 percent to 5 percent allocation to each stock at the time of recommendation.

The buying and selling would of course depend on the discount and the premium to our understanding of the true value of these stocks.

Worth pointing out here this allocation is extremely crucial. It is this allocation that will play a key role towards meeting our return objectives.

And what better way to identify stocks for this allocation than to lean on Warren Buffett’s time-tested strategy.

So, we have now taken care of the 65 percent of the overall allocation on the lower side and 80 percent on the higher side.

What about the remaining 20 percent to 35 percent allocation for our Double Income Map? Where should this money be invested?

This is where our third guru, Jack Bogle enters the scene.

I’ll write about his insights in my next piece.

Stay tuned.

 

(This post is a joint initiative between Moneycontrol and Equity Master. Rahul Shah is Equitymaster’s Co-head of Research. He has more than 16 years’ experience in equity research and building investing systems)

Disclaimer: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. This Article is for information purposes and is not providing any professional/investment advice through it and Equitymaster disclaims warranty of any kind, whether express or implied, as to any matter/content contained in this Article, including without limitation the implied warranties of merchantability and fitness for a particular purpose. Information contained in this Article is believed to be reliable but Equitymaster does not warrant its completeness or accuracy. Equitymaster will not be responsible for any loss or liability incurred by the reader as a consequence of his taking any investment decisions based on the contents of this Article. The reader must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary.

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First Published on Nov 27, 2019 04:11 pm
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