The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [164]
He looks for what he calls “franchise” companies with strong consumer brands, easily understandable businesses, robust financial health, and near-monopolies in their markets, like H & R Block, Gillette, and the Washington Post Co. Buffett likes to snap up a stock when a scandal, big loss, or other bad news passes over it like a storm cloud—as when he bought Coca-Cola soon after its disastrous rollout of “New Coke” and the market crash of 1987. He also wants to see managers who set and meet realistic goals; build their businesses from within rather than through acquisition; allocate capital wisely; and do not pay themselves hundred-million-dollar jackpots of stock options. Buffett insists on steady and sustainable growth in earnings, so the company will be worth more in the future than it is today.
In his annual reports, archived at www.berkshirehathaway. com, Buffett has set out his thinking like an open book. Probably no other investor, Graham included, has publicly revealed more about his approach or written such compellingly readable essays. (One classic Buffett proverb: “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”) Every intelligent investor can—and should—learn by reading this master’s own words.
No matter which techniques they use in picking stocks, successful investing professionals have two things in common: First, they are disciplined and consistent, refusing to change their approach even when it is unfashionable. Second, they think a great deal about what they do and how to do it, but they pay very little attention to what the market is doing.
Chapter 16
Convertible Issues and Warrants
Convertible bonds and preferred stocks have been taking on a predominant importance in recent years in the field of senior financing. As a parallel development, stock-option warrants—which are long-term rights to buy common shares at stipulated prices—have become more and more numerous. More than half the preferred issues now quoted in the Standard & Poor’s Stock Guide have conversion privileges, and this has been true also of a major part of the corporate bond financing in 1968–1970. There are at least 60 different series of stock-option warrants dealt in on the American Stock Exchange. In 1970, for the first time in its history, the New York Stock Exchange listed an issue of long-term warrants, giving rights to buy 31,400,000 American Tel. & Tel. shares at $52 each. With “Mother Bell” now leading that procession, it is bound to be augmented by many new fabricators of warrants. (As we shall point out later, they are a fabrication in more than one sense.)*
In the overall picture the convertible issues rank as much more important than the warrants, and we shall discuss them first. There are two main aspects to be considered from the standpoint of the investor. First, how do they rank as investment opportunities and risks? Second, how does their existence affect the value of the related common-stock issues?
Convertible issues are claimed to be especially advantageous to both the investor and the issuing corporation. The investor receives the superior protection of a bond or preferred stock, plus the opportunity to participate in any substantial rise in the value of the common stock. The issuer is able to raise capital at a moderate interest or preferred dividend cost, and if the expected prosperity materializes the issuer will get rid of the senior obligation by having it exchanged into common stock. Thus both sides to the bargain will fare unusually well.
Obviously the foregoing paragraph must overstate the case somewhere, for you cannot by a mere ingenious device make a bargain much better for both sides. In exchange for the conversion privilege the investor usually gives up something important in quality or yield, or both. 1 Conversely, if the company gets its money at lower cost