Is Warren Buffett Really A Value Investor?
He's one of the most famous investors of all time and has certainly earned his nickname of "The Oracle of Omaha". Warren Buffett has long been hailed as a value investor. But is that statement still accurate?
TUTORIAL: P/E Ratio
What Is Value Investing?
Value investing can mean a number of different things, but is generally meant to refer to a class of investors who look for investments trading at a price below where certain valuation fundamentals suggest they should be trading at. For example, a stock can trade at a price-to-earnings (P/E) or price-to-book (P/B) value below its peers or the market average in general. Overall, value investing is an investment philosophy of finding undervalued securities that should eventually increase in value to be closer in line with (or above) the metrics of rivals or stock market averages.
On the flip side, growth investors are said to be more interested in the growth potential of a security whose underlying company has above-average sales or profit expansion prospects. Given this higher growth potential, a growth investor may be willing to pay above-average P/E, P/B or other valuation metrics compared to rivals or the market in general.
The value investing crowd has its origins in the 1934 text "Security Analysis" by Benjamin Graham and David Dodd and has been further developed by Warren Buffett, a past student of Graham who has also preached that a security eventually trades up to its intrinsic value. Buffett championed Graham's approach to buy a security with a satisfactory margin of safety, or, in Graham's words, "a favorable difference between price on the one hand and indicated or appraised value on the other." (This simple measure can help investors determine whether a stock is a good deal. For more, see Value Investing Using The Enterprise Multiple.)
Where Does Buffett Fit?
In this context, Buffett is considered a value investor. More specifically, he relies on estimating a firm's future cash flows and discounting them back to the present to get an estimated intrinsic value for a company when it comes to investing in its stock. Intrinsic value is a theoretical value assuming one could know a firm's future cash flows with certainty, so the reality is that it is a very subjective measure and investors may come to widely varying estimations of intrinsic value, even when looking at the same set of data, valuation metrics, etc.
But in the context of value versus growth investing, Buffett is actually a bit of both. In his words, "growth and value investing are joined at the hip" and that understanding is required to find a company and underlying stock with solid growth prospects and a market value well below intrinsic value. The best illustration of this is the growth of Berkshire Hathaway's non-insurance businesses over the past four decades. Below is a chart that Buffett provided in Berkshire's 2010 shareholder letter:
Period Annual Earnings Growth
1970-1980 20.8%
1980-1990 18.4%
1990-2000 24.5%
2000-2010 20.5%
Over this time period, earnings growth averaged 21% annually while Berkshire's stock price grew at an annual compounded rate of 22.1%, almost completely mirroring the growth in earnings. In this respect, Buffett is the ultimate growth investor because earnings grew about twice the level of the stock market during this period. In Buffett's words from this year's shareholder letter, "market prices and intrinsic value often follow very different paths - sometimes for extended periods - but eventually they meet." (Find out how Mr. Market's mood swings can mean great opportunities for you. See Take On Risk With A Margin of Safety.)
The Bottom Line
Again, perhaps the most appropriate conclusion to make is that Buffett is both a value and growth investor. At the outset of making an investment, it is reasonable to conclude that he uses a margin of safety by purchasing a stock with valuation metrics that are well below average. But overall, growth has to be there so that the firm can eventually trade up closer to its intrinsic value and growth potential must be well above average to double the market's return over the long haul.
To be a truly successful investor, individuals must take both a value and growth perspective when it comes to spotting undervalued investments and outperforming the market over time. Valuation multiples including P/E and P/B ratios are a good starting point, but at the end of the day it is also necessary to estimate a firm's growth prospects and cash flows going forward, and come to an independent determination of intrinsic value.
