Problems with Cigar Butt Investment

Cigar Butt Investment

What is Cigar Butt investment?

Most investors who have a little research on Buffett may know that Buffett used his own investment in the early stage of his investment career, especially during the Warren Buffett partnership that had not yet established Berkshire (ticker:s: BRK.A and BRK.B), is his mentor Graham’s “Cigar Butt Investment Method” means:

  • Only study the company’s financial report
  • Identify companies whose value is undervalued
  • Doesn’t consider non-quantitative factors at all
  • When the stock price of the target company rises above its intrinsic value, it will be sold out.
  • Look for the next investment target

The market might find out in several years later

In the 1961 Buffett Partnership’s annual letter to shareholders, it was mentioned that “sometimes the value correction will be very fast, but most of the time it takes a year or even several years to achieve. It is often difficult for us to know exactly when we buy. Know when a stock will appreciate at its current price level.” Therefore, this company must be able to survive until then, or it may go out of the market or close down before that time.

Lead to diversified investment

Since only study financial reports, and must wait for the market to discover the value of the target company, in most cases you must buy many different companies to win by volume.

Circle of competence or competitiveness not considered

In this way of investment, the main consideration is basically the margin of safety. The so-called ability circle investment is not considered at all, and the competitiveness of the company is not considered at all. There is only one simple consideration, which is cheap enough and substantially lower than the intrinsic value.

Target is usually a small business with poor quality

Just like Munger’s famous saying, “High-quality, excellent companies usually have unattainable stock prices.” Most of these investment opportunities are unknown “second-rate companies, third-rate prices” or “third-rate companies, fourth-rate prices.” If you study Buffett carefully, his most famous early investment cases, Sanborn Map and Dempster Farm Tools, belong to this category.

“Although the stocks we hold are cheap, the cheap price of a thing does not mean that its price will not continue to fall. When the market falls, this part of us will also fall.” Buffett in 1961 also mentioned it in the partnership’s annual letter to shareholders.

Long-term investment not considered

According to this investment method, as long as the stock price rises above the recognized intrinsic value of the company, it will be released. Long-term holdings are not considered, and of course compound interest over time is not considered. The greatest advantage of holding stocks is completely lost, and it is difficult to accumulate substantial wealth.

Experienced senior investors know that small businesses with poor quality are usually the sorting targets. What’s worse is that in the long run, it is hard to escape the fate of being off the market, that is, the funds you invest may be in vain.

How does it affect Buffett

Smart readers may have thought that if Buffett had used this investment method throughout his life, it would be difficult for him to accumulate current assets, achieve current amazing achievements, and return on investment — at best, he would be just a rich man. Graham’s investment is not very successful in terms of rate of return. Graham’s main achievement is to establish a systematic and feasible modern investment theory.

You and I all know about the subsequent development. Buffett drastically modified this set of investment methods:

  • Instead of simply using working capital, use discounted cash flow (DCF) and private market valuation as the margin of safety when investing.
  • Affected by the great influence of Charlie Munger, after the real case verification of the acquisition of See’s Candies — the invisible value of non-quantitative, future growth rate of the company, long-term outlook of the company, market share, management team ability, and moat was added, as an important consideration when investing.
Cigar Butt Investment
credit: Flickr

Buffett quickly discovered the problem with the cigar butt investment law. If he hadn’t adjusted it sooner, we probably wouldn’t know this guy in the investment world today because he wouldn’t have become so successful and great. — This is what makes Buffett great. You can refer to my other article “Why Buffett deserves further study?

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