On Warren's Wavelength

Few would argue with the proposition that Warren Buffett is the world's greatest living investor. In the 41 years that he has been at the helm of Berkshire Hathaway BRK.B, per share book value has grown from $19 to $59,377, or 21.5% compounded annually. Despite insurance losses estimated at $3.4 billion in 2005 due to hurricanes Katrina, Rita, and Wilma, Berkshire Hathaway managed to increase net worth by $5.6 billion in 2005, for a 6.4% increase in book value.

Any advisor or financial planner worthy of the name would be overjoyed to produce annual returns that top 20% over a 10-year period, let alone a 40-year period. As a result, advisors are constantly on the lookout for "the next Warren Buffett" or, failing that, a skilled investor who exhibits similar investment tendencies.

The Man
Understanding Buffett's investment philosophy is not as difficult as one might imagine, although putting it into practice is considerably more difficult. Ten years ago, Buffett himself wrote an "owners manual" for Berkshire Hathaway shareholders. In it, he highlighted the firm's broad economic principles of operation:

1. Treat shareholders as partners
2. Managers and directors should have a substantial stake in the business (eat your own cooking)
3. Maximize the average rate of gain in intrinsic business value on a per share basis
4. Own a diversified group of businesses that generate cash and consistently earn above average returns on capital
5. Ignore consolidated numbers. Concentrate on the economics of each business
6. Do not allow accounting rules to influence operation or capital allocation decisions
7. Use debt sparingly. When you do use it, try to borrow long term at fixed rates
8. Only purchases businesses at prices capable of increasing the intrinsic value of the firm
9. Retain earnings only if you can earn an acceptable return on them
10. Don't issue common stock unless you receive as much value as you give
11. A reluctance to sell the businesses they own
12. Report candidly to shareholders
13. Good investment ideas are rare

While each principle outlined above is not directly applicable to the mutual fund world, managers Bruce Berkowitz, Wally Weitz, and David Winters, who will appear together June 30 on a panel titled "On Warren's Wavelength" at the Morningstar Investment Conference, apply at least some of these principles in their investment processes.

Before we get to the managers, however, there is one more point that needs to be addressed: If Buffett is such a successful investor, why not just buy Berkshire Hathaway itself, thereby gaining access to his investment prowess directly? The answer is that perhaps you should, but there are a few caveats.

First, by Buffett's own admission in Berkshire's 2005 annual report, the firm's existing businesses are expected to generate "in aggregate, modest growth in operating earnings" in the years ahead. To produce truly satisfactory earnings in the years ahead, Berkshire will have to make major acquisitions that can add to the bottom line. While Buffett has been able to do so in the past, there is no guarantee that he can continue to do so in the future. A second impediment is Berkshire's sheer size. With assets of $200 billion, the universe of acquisitions that can make an impact on the bottom line is somewhat limited. Third, there is concern over succession. Buffett, and his partner, Charlie Munger, aren't getting any younger. If something were to happen to one or both of them, what effect might that have on the price of the stock?

Clearly, these concerns have not influenced the outlooks of Berkowitz, Weitz, and Winters with regard to Buffett and Berkshire Hathaway. All three own the stock.

But perhaps the best rationale for not owning the stock directly comes from Berkowitz: "With regard to Berkshire Hathaway, or any stock for that matter, you have to constantly evaluate the businesses you invest in. We own it. If it got to the point where it was not a good investment for our shareholders, we would sell it. If it came down in price to the point where it became attractive again, we would repurchase it. The typical shareholder in our fund is not as well equipped as we are to make that call."