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Newsweek,
but prof itability at the newspaper was leveling off. The pri-
mary reason, she said, was high production costs, namely wages.
After the Post purchased the
Times-Herald,
profits at the company
had surged. Each time the unions struck the paper (1949, 1958, 1966,
1968, 1969), management had opted to pay their demands rather than
risk a shutdown. During this time, Washington, DC, was still a three-
newspaper town. Throughout the 1950s and 1960s, increasing wage costs
dampened profits. This problem, Mrs. Graham told the analysts, was
going to be solved.
As union contracts began to expire in the 1970s, Mrs. Graham en-
listed labor negotiators who took a hard line with the unions. In 1974,
I n v e s t i n g G u i d e l i n e s : F i n a n c i a l Te n e t s
1 1 7
the company defeated a strike by the Newspaper Guild and, after lengthy
negotiations, the printers settled on a new contract.
In the early 1970s,
Forbes
had written, “The best that could be said
about The Washington Post Company’s performance was it rated a gen-
tleman’s C in prof itability.”
8
Pretax margins in 1973 were 10.8 per-
cent—well below the company’s historical 15 percent margins earned
in the 1960s. After the successful renegotiation of the union contracts,
the Post’s fortunes improved. By 1978, prof it margins had leaped to
19.3 percent—an 80 percent improvement within f ive years.
Buffett’s bet had paid off. By 1988, the Post’s pretax margin reached
a high of 31.8 percent, which compared favorably with its newspaper
group average of 16.9 percent and the Standard & Poor’s Industrial aver-
age of 8.6 percent. Although the company’s margins have declined some-
what in recent years, they remain substantially higher than the industry
average.
T H E O N E - D O L L A R P R E M I S E
Buffett’s goal is to select companies in which each dollar of retained
earnings is translated into at least one dollar of market value. This test
can quickly identify companies whose managers, over time, have been
able to optimally invest their company’s capital. If retained earnings are
invested in the company and produce above-average return, the proof
will be a proportionally greater rise in the company’s market value.
In time, that is. Although the stock market will track business value
reasonably well over long periods, in any one year, prices can gyrate
widely for reasons other than value. The same is true for retained earn-
ings, Buffett explains. If a company uses retained earnings unproduc-
tively over an extended period, eventually the market, justifiably, will
price its shares disappointingly. Conversely, if a company has been able
to achieve above-average returns on augmented capital, the increased
stock price will ref lect that success.
Buffett believes that if he has selected a company with favorable long-
term economic prospects run by able and shareholder-oriented managers,
the proof will be ref lected in the increased market value of the company.
And he uses a quick test: The increased market value should at the very
least match the amount of retained earnings, dollar for dollar. If the value
I n v e s t i n g G u i d e l i n e s : F i n a n c i a l Te n e t s
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As we have learned of one accounting scandal after another, it has
become even more critical for investors to delve into these f inancial
areas. There is no guarantee that through this effort you will fully un-
cover the truth, but you will have much greater chance of spotting
phony numbers than if you do nothing. As Buffett remarks, “Managers
that always promise to ‘make the numbers’ will at some point make
up
the numbers.”
10
Your goal is to begin to learn to tell the difference.
1 2 1
8
Investing Guidelines
Value Tenets
A
ll the principles embodied in the tenets described so far lead to
one decision point: buying or not buying shares in a company.
At that point, any investor must weigh two factors: Is this com-
pany a good value, and is this a good time to buy it—that is, is the
price favorable?
The stock market establishes price. The investor determines value
after weighing all the known information about a company’s business,
management, and f inancial traits. Price and value are not necessarily
equal. As Warren Buffett often remarks, “Price is what you pay. Value
is what you get.”
If the stock market were truly eff icient, prices would instanta-
neously adjust to all available information. Of course, we know this
does not occur. Stock prices move above and below company values for
numerous reasons, not all of them logical.
It’s bad to go to bed at night thinking about the price of a
stock. We think about the value and company results; The
stock market is there to serve you, not instruct you.
1
W
ARREN
B
UFFETT
, 2003
1 2 2
T H E W A R R E N B U F F E T T W AY
Theoretically, investors make their decisions based on the differ-
ences between price and value. If the price is lower than its per share
value, a rational investor will decide to buy. If the price is higher than
value, any reasonable investor will pass.
As the company moves through its economic life cycle, a savvy in-
vestor will periodically reassess the company’s value in relation to mar-
ket price and will buy, sell, or hold shares accordingly.
In sum, then, rational investing has two components:
1. Determine the value of the business.
2. Buy only when the price is right—when the business is selling at
a signif icant discount to its value.
C A L C U L AT E W H AT T H E B U S I N E S S I S W O R T H
Through the years, f inancial analysts have used many formulas for de-
termining the intrinsic value of a company. Some are fond of various
shorthand methods: low price-to-earnings ratios, low price-to-book
values, and high dividend yields. But the best system, according to Buf-
fett, was determined more than sixty years ago by John Burr Williams
(see Chapter 2). Buffett and many others use Williams’s dividend dis-
count model, presented in his book
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