Sowing Seeds is a 4-part series about investing. It’s based on having studied several successful value investors with a strong bias toward treating equities as partial business ownership and not as lottery tickets.
First: Part 1, Market value is imaginary
Then: Part 2, The economy is irrelevant
Finally: Part 3, The second best buzz
Bonus: Part 4, Water your own tree, slowly

I tend to obsess over things… So for the last few years, it’s been Warren Buffett and the stock market.

The most ideal situation would be to have lunch with Warren Buffett and get his take on things. I suspect that most people who sat down with him and heard him say, “You should do A, B and C” would do exactly what he said. So how do we get that info? Actions always speak louder than words, so why not just copy what he does?

What did Buffett buy?

The problem with that is that journalists are a dime a dozen who can tell you what stocks Buffett holds, but very few report what he bought them for. Buffett holds a freighter full of Coke shares, but that’s not enough information, because it doesn’t tell us what his cost is. It doesn’t tell us if he thinks Coke is still a good deal today.

The cost of your investments is more important than their market value, because it’s real money. It’s money you made playing guitar or selling hats, and at one time it was in your bank account. In contrast, market value has never existed except in people’s imaginations. “If I sold now, I’d make…” or “If I would have kept those shares, today I’d have…” but both mean nothing. It’s like saying, “I started playing guitar when I was six. If I would have kept playing, I’d be awesome now…”

If you put money into the stock market and it doubles, it’s exciting, but it doesn’t really mean anything until you turn it into cash and put it back into your bank account. If you put it into the stock market and the value gets cut in half, it sucks emotionally, but it means nothing in practical terms unless you sell or the stock disappears entirely (which really means you bought shares in a crappy company to start with).

So if we’re going to try to mimic Buffett (or any other successful investor), it’s not enough to know what stocks he holds. We also need to know what his cost is.

Stocks aren’t lottery tickets

A key Buffett tenet is that when you buy a stock, you’re not buying a meaningless piece of paper that someone may or may not pay you more or less for. You’re buying a real piece of a real company. That being the case, you should approach buying stocks as if you were buying the whole company, and thinking that you were going to own it for at least ten years. (If you were going to buy the corner store in your neighborhood, would you go through all the due diligence required just to sell it in six months?)

From this point of view, questions that need to be asked include (but are not limited to):

• Is management competent and sound?
• Is management honest and trustworthy?
• Does the business have favorable long-term prospects? Does the company have a competitive advantage?
• Most importantly, is the company for sale (via its shares) at a significant discount that offers the investment a significant margin of safety?

In other words, has the moodiness of the market unjustly determined a current stock price that severely understates the intrinsic value of the company?

But who has the time to evaluate each stock they buy as if they were buying the whole company? Answer: Mr. Buffett.

The magic of dividends

Another thing in our favor is that Buffett’s favorite holding period is forever. If he’s confident in his investments, he plans on never selling. This tells us a couple things, most importantly, that Buffett isn’t buying stocks; he’s buying cash flow in the form of dividends. Played properly, this works way better than any fixed income investment ever will… Here’s why:

1. You buy a stock for $50 that has a dividend yield of 3%;
2. So for your $50, the company will pay you $1.50 every year;
3. If the company is sound, the stock price will probably rise over the long-term, and the dividend will likely keep pace with the stock price;
4. So if the stock value increases to $100, the yield may increase to $3. Still 3%, right?
5. No, because your cost is $50. So now you’re making 6% on your money;
6. But since the stock has hit $100 and people have an irrational resistance to high stock prices, the company splits the stock 4:1;
7. So now you have four shares worth $25 each, rather than one worth $100, each paying $0.75 (6%);
8. But if it’s a well-managed company with favorable long-term prospects…;
9. Etc, etc.

That’s how Buffett invested in Coke in 1988. The stock has increased in value and split a few times so that today the stock is trading just under $60, paying a dividend of $1.52. But Buffett’s per-share cost is around $6.50. So he’s making 23% per year on his cost…

Today is an opportunity

In the last year, there have been several opportunities to buy great companies at bargain prices. Of course, it could all go to downhill tomorrow, but it honestly doesn’t matter. Any depression in values just gives value investors another opportunity to buy great companies even cheaper, making the eventual slingshot in market value and dividend yields even more positive down the road.

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