If you are a true value investor you must have studied this investment paradigm for years or even maybe decades. There are dozens of books, audio tapes, and videos that explain to you what exactly value investing is.
Most individuals will read about Warren Buffet, the CEO of Berkshire Hathaway. Typically, investors will follow Buffett religiously, buying every single stock he purchases and doing everything the way he does it. Some people may have been successful while others may not have been quite as fortunate as Buffett.
The rules of value investing strictly deal with the concepts of fundamental analysis. This is the key mathematical measurement to figure out if a stock is cheap or not. Fundamental analysis is the primary tool that Buffett has used for decades with immense success. In some cases, it works well and sometimes it may not, especially during a bear market.Credit: Wikimedia Commons
So, what is one of the secrets regarding value investing that you are unaware of? It is something that Buffett talks about regularly, but people tend to ignore him when he speaks about it. When Buffett talks on CNN or CNBC he always mentions a farm. Most people laugh and just listen in for the stocks Buffett will talk about next.
Buffett uses the analogy of owning a farm and compares it to owning stocks for three specific reasons. First, a farm represents a property with valuable assets and the capability to produce products (soy beans, corn, wheat, etc.). Most importantly, the farm's assets will always be there, no matter what. As long as the crops are being grown, the farmers can sell their products. If a major catastrophe hits the farmland, the farmers have insurance. Moreover, a farm owns cattle and other valuable animals. Certain animals will produce a product and/or engage in various different physical jobs. You will notice that many of Berkshire’s companies have immense assets and are simple businesses to comprehend just like a farm.
Second, Buffett looks very closely at demographics. If a farm owner lives in a county of one million people he can sell his crops to those one million individuals. What if the farmer wants to sell the crops to the entire state? Or even the whole country? Now, do you see the potential upside?
This concept works the exact same way when it comes to Berkshire’s companies, they sell products so that virtually anyone can buy them, even on a national or international scale. Currently there are 330 million people living in the United States. By 2050, that number will hit 400 million. Wouldn't a farmer want to sell his products nationwide to virtually every American?Credit: Wikimedia Commons
Lastly, Buffett uses the farm analogy because increasing crop production is simple to do. Just like a company that sells a household product is easy to make, it is also simple to produce in larger quantities. All that has to be done is expand the acreage of the farm, hire more employees, and maintain the overall operations. On the other hand, sometimes value investors tend to look in different directions and insert capital into other riskier stocks, completely forgetting about Buffett's simple analogy.
When you look at value investing, think of a farm and how it correlates directly with Berkshire's companies. Buffett keeps it simple and keeping it simple means making a profit. Remember, as long as a company has valuable assets, a strong clientele, and a simple operation, it will probably remain as a part of Buffett's multi-billion dollar empire.
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