Written by Marc Courtenay

Wednesday, 11 October 2006

Back in the 1990s we enjoyed studying the investment interests of two of the most successful investors we knew of. Warren Buffet and Richard Rainwater invested in different directions, but they seemed to know of some of the same secrets of outstanding investors. Both Buffet and Rainwater avoided the temptation to invest in the "New Economy" stocks, especially the internet and the dot.com companies. They would not succomb to the hype and hysteria (an important fundamental of great investors--think independently).  They both liked companies that they could understand and grasp how they made money. They wanted these companies to be undervalued and generating some nice profits.

Richar Rainwater came to the conclusion that the world was beginning to use more oil and natural gas than it was producing...or he sensed that consumption of energy was really about to take off. With Russia, China and India entering the global economy and their citizens becoming modernized, there would be greater demand for energy in the future and possibly shortages of oil and natural gas. Rumor has it that he purchased the assets and shares of a little company named Energy Services. He bought drilling rigs, platforms and other oil services equipment at pennys for a dollar. Today that company is called Ensco  International (symbol ESV) and Rainwater made hundreds of millions in profits. At least that is the way we heard it told.

Buffet was buying financial service companies and prizes like GEICO. At the time many professional observers just kept saying that Rainwater and Buffet just didn't get it and they were missing the boat. What a joke!  Looking back we can see why both men have become extraordinarily wealthy, and if we had bought some of their investments with them (we still kick ourselves...for we passed up in the 1990s a chance to buy Energy Services Corp. at $1 per share) we would all be much richer. A $10,000 investment in Buffet's and Charlie Munger's company, Berkshire Hathaway (symbol BRK.A) back in 1965 would today be worth over $30 million dollars!  Will we recognize the next great investors and follow their example? 

We will if we remember some of the secrets about how to invest like "The Big Dogs". Here are a few:

Great Investors are not afraid to invest in unpopular ideas or unfashionable companies. They seek them out instead. These are typically the stocks that are discounted in price and represent great value.

Benjamin Graham, the author of the classic book on value investing (The Intelligent Investor) and Buffet's mentor, referred to these undervalued investments as "cigar butt" companies--no longer prized by the market and thus discounted greatly, but which have a few puffs left (and more profits yet ahead).

Great Investors really do their homework. They are not afraid to do exhaustive research and are willing to pay for the best recommendations and analysis. Rainwater's wife said his investment prescience is almost "eerie", but we suspect it is more the result of almost obsessive examination of the issues and circumstances surrounding the investments he is focused on. He reads everything that he can get his hands on regarding his targets. He talks to experts, checks the data, and then re-checks. Only after he has done his "super due diligence" and has identified what he is certain is an "exceptional opportunity" does he make his move.

Buffet and Rainwater will only invest in businesses they like and understand. In a recent Berkshire annual report Buffet wrote, "Whenever we buy common stocks...we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale. Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate. When investing, we view ourselves as business analysts--not as market analysts, not as macroeconomic analysts and not even as security analysts." Sounds like he considers himself a "partner" when he buys the shares of a publicly-traded company.

Right now, one way to follow their example might be to be looking at some of the most successful energy companies whose stock prices seems darn cheap to our mentors (see today's Money Rumor Mill for details). Just because oil as dropped from $78 a barrel to $57, doesn't mean it won't go back up someday in a New York minute. Same with natural gas. So the more these companies and their shares are hated, the more interested we all should get...if we are following the investment style of the "Big Dogs".  We want to thank the folks at Investor's Daily Edge, a free, daily e-newsletter, and especially Andrew Gordon for sharing some good insights along these lines.  Hats off to the great investors and  to those who recognize them!