Morningstar Advisor - Fall 2008 - (Page 46)

Morningstar Conversation great value investor, but Bill was making such a wonderful reputation off of identifying mispricing, or value propositions, in the growth space. For me, it was not that difficult to make the segue from Warren Buffett Way-land into Legg Mason, because Bill had already moved Buffett into the growth space and had done very well. I really wanted to take the ideas of The Warren Buffett Way and move it into a new menu of stocks. Clearly, you could buy Warren Buffett stocks—the American Expresses, the Cokes, and the Gillettes—and follow the bread crumbs along the way. There are many great investors who have followed the Buffett approach and have done extremely well buying pretty much the same stocks that he did. In the book, I had already argued that these principles should apply to any part of the market—whether it’s small cap, large cap, slower growing, rapidly growing. For myself, I really wanted to move into new areas in which Warren was not active to see how well I could do. KK: Did you make some mental adjustments to accomplish that? RH: I had to make a lot of mental adjustments, cash-flow estimates were going to have a wider potential outcome. The way I thought about it was that even though the cone was somewhat wide compared to Coke or Gillette, the payoff—if I was right—would certainly more than compensate me for that risk. KK: But do you ask for an even larger discount because those that follow Warren know his conservative style. I like to say that Warren buys “certainties at discounts.” He wants high predictability of cash flows. When you go into the growth space—into technology, Internet, wireless communications, and others—the cone of uncertainty is a little wider than it is for soda pop and razor blades. It’s harder to estimate cash flows out five and 10 years as you move into the Internet space and the technology space. I had to get comfortable with knowing that my before you buy? RH: Sure. As you know, Warren doesn’t think about equity risk premiums. He discounts it at the long bond rate. He’s probably adjusted that up, but if you even think about a 10% discount rate, the riskier that the cash flows become, the greater the discount that you want. If you have something with high predictability, you need less of a discount to make that judgment. KK: What are your biggest challenges in running this type of strategy? 46 Morningstar Advisor Fall 2008

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Morningstar Advisor - Fall 2008 Contents New on MorningstarAdvisor.com Letter from the Editor Contributors Inbox Are You Preparing for Higher Taxes? State of Financials Oracles of Alabama Investment Briefs Managers’ Investment Secrets Revealed Conformity Becomes a Growing Concern at American Gimme Shelter Location, Location, Location Rooted in Buffett, Going for Growth Keeping Little Company Away from the Numbers Consumer Confidence What about Natural Gas? TIPS to Beat Back Inflation Investing in Hidden Assets Funds That Have an Edge Come Tax Time Mutual Fund Analyst Picks 50 Most Popular Equity ETFs Undervalued Stocks Most Popular Variable Annuities New at Morningstar One for You, 19 for Me

Morningstar Advisor - Fall 2008

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