Editor's note: This is the first in a series of profiles of stellar growth-stock investors.
NEW YORK (
) -- Most mutual fund managers -- and most funds --fall into one of two broad investment style categories: value or growth.
Value investors typically buy shares of companies that trade at relatively modest prices for one reason or another. For example, a value investor might buy neglected or unpopular shares of companies that have suffered a temporary earnings shortfall or that own undervalued assets. By contrast, growth investors may be willing to pay premium prices for companies that have strong growth potential.
Some of the most famous growth investors have had a powerful influence on today's fund managers, who draw heavily on their ideas and techniques to choose the stocks that populate their current portfolios. With that in mind, I have created profiles of several stellar growth stock investors. I offer one of them below, with more to come over the course of the month.
Back in the early 1950s, Buffett, chairman and CEO of
, went to Columbia Business School to study with Benjamin Graham -- often known as the father of value investing as well as securities analysis itself. But the Oracle of Omaha, as Buffett is known, emerged from his training to become one of the world's most successful growth investors in the second half of the 20th century.
He did it by identifying companies that could deliver superior long-term growth. What's more, he often bought those firms' shares when they traded at premium prices that knocked them off traditional value-oriented stock screens.
Buffett started out buying shares of companies that were trading at deeply depressed prices -- just as Ben Graham had taught him. His purchases included shares of an anthracite company and a windmill company. He found that many of his stocks went nowhere.
After taking a closer look at the underlying companies, he realized the reason that the shares weren't making money: The companies themselves weren't making profits. Their shares were cheap because the companies were in businesses that were suffering.
Buffett decided that buying a bad business--no matter how cheaply--was bad business. He wanted to buy shares of companies that could generate superior profits over time.
Buffett decided that he should stick to shares of firms that could earn consistently high profit margins. He identified those firms by conducting a series of interviews with a firm's executives, customers, suppliers and competitors to form a picture of the companies' prospects. Finally, Buffett believed that owning shares of a small number of promising firms was better than owning dozens of different stocks of mediocre ones.
Buffett also stayed loyal to a lesson he'd learned from Ben Graham: Try to pay less for a business than its underlying value. True, Graham had identified a company's value by scouring its financial statements for hidden (and not-so-hidden) assets such as cash or receivables. Buffett, by contrast, was willing to look for value in intangible factors such as a company's growth prospects.
Warren Buffett's own contribution to growth stock investing was in refining the search for companies that could deliver exceptional growth over long periods. He looked (and continues to look) for companies that possessed a series of clearly defined characteristics, including these:
A business he understands. Buffett missed out on some of the profits in the technology sector during the roaring '90s because he didn't understand the business models of the emerging companies. He also sidestepped the huge losses that occurred when it turned out that many high tech darlings didn't have business models at all. Recently, I wrote an
on Buffett's investment in
. Though the investment has yet to pay off, GE is a company that Buffett knows and understands. Therefore, he considers it a worthwhile investment that is likely to benefit him in the future.
Strong competitive advantages. For example, Buffett values companies with strong franchises that help them fend off competition. Other barriers to entry might include sheer size or high cash flow that can be used to buy advertising, create new products or ride out downturns in an industry or sector. Buffett's investment in
, the company responsible for the first mass produced
, is a great example of this quality.
An exceptionally high rate of return on capital. Simply put, he wants to buy shares of companies that earn high profits on each dollar they invest in their business. Berkshire Hathaway's investment in
recently earned Buffett an
. Enough said.
Lessons of the masters
Fortunately, you don't have to be an investing genius yourself to reach your own investment goals. Instead, you can rely on the stock-picking skills of first-rate fund managers -- many of whom have learned the lessons of these and other masters. That said, the more you know about investing, the more confidence you'll have when you're making judgments about your portfolio of funds or other investments.
-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion did not own any of the equities mentioned.
Don Dion is president and founder of
, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.
Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.