Source: Wealth Creator Magazine May/Jun 2006

Warren Buffett is undoubtedly the world’s most successful stockmarket investor, with a worth of US$44 billion (AU$54 billion.)

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Warren Buffett's Secret Formula. Or Why The Tech Boom Was Wrong

Source: Wealth Creator Magazine May/Jun 2006

Warren Buffett's secret formula. Or why the Tech Boom was wrong. But not completely.

Buffett is famous for his original investment formula, what he called ‘picking up discarded cigar butts from the bin to smoke the remaining puffs’ – which was to focus on a company’s earnings and pay as little as possible, ignoring Wall Street trends. So simple and logical, that was how he originally started investing in 1965 after reading The Intelligent Investor by Benjamin Graham.

The method

He was certainly successful using this method. But the real growth in the Buffett fortune – turning him into one of the wealthiest men in the world – came not from ‘cigar puffs’, but by paying more for shares than what his cigar puff formula would have allowed.

Coca-Cola Co. is a good example. In 1988, when Buffett started buying the global soft-drink giant, it was trading at US$10.96. The old Buffett wouldn’t have touched it, because the balance sheet didn’t justify the price. But he saw the world’s strongest brand name and how this could be translated into overseas sales – factors which were not on the balance sheet. In less than five years, the stock soared to US$74.50. Buffett’s current stake is valued at US$13 billion.

He recognised that the biggest intellectual property asset in Coca-Cola – the brand – was worth a premium. Buffett talks about the importance of ‘the presence of a competitive advantage. You want a business with a big castle and a moat around it, and you want that moat to widen over time’. Intellectual property is the best moat-and-castle combination because it is a 100% legal method of stopping competitors from stealing customers.

IP

Buffett made his investors very rich by buying into companies which had great intellectual property – like American Express and Gillette.

Most recently, the investing community recognised that other types of intellectual property could be valuable, paying high prices during the technology boom. The high valuations weren’t for land or equipment, they were for the intellectual property of the companies.

The subsequent crash showed that it was possible to pay too much for a stock, and prices have now gone back to ‘normal’.

Wealth building

But the lesson has stuck. Intellectual property, whether for brands, product designs or technology patents, means money. Forbes magazine calls intellectual property the ‘wealth building asset of the future’. Invest in companies that have good intellectual property and hang on for the ride.

What does that mean for an investor? If every company has intellectual property and it’s all valuable, how do you allocate your funds?

Obviously, it’s not all valuable. It can’t be, otherwise every company would be successful.

Intellectual property is a form of property, and not all property is of the same value. One acre in Double Bay, Toorak and Alice Springs all have different value. In fact, even within the same suburb there are differences. The Double Bay property overlooking the harbour is far more valuable than the Double Bay property next to the train line.

Rental returns – current earnings in the world of share investing – are only part of the story. They pay for the loan interest. But if you want capital growth you have to look for something else. The trick is to sort out the good from the worthless. Valuing intellectual property is done using its own set of criteria.

As a lawyer practising only in intellectual property, we work with large clients who commission us to analyse intellectual property and prepare reports for them on how good or bad it is – part of their due diligence process before committing investment funds.

Naturally, when it comes to investing my own money, I choose companies based on the quality of their intellectual property.

In the next issue of WCM, we will look at a case study – Jumbuck Entertainment Ltd, an Australian company whose share price has increased 470% in the last year, and the key intellectual property triggers that signal a good investment.

Written by:

Trevor Choy is the principal of Choy Lawyers, the winner of Best Intellectual Property Law Firm at the Australian Law Awards 2005.

Choy Lawyers looks after the brands of several companies from the BRW top 1000 and BRW 100 fastest-growing companies lists.

www.choylawyers.com.au