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Cheap compared with what it becomes
Value 1.0 and 2.0
Ben Graham's version, value 1.0, was a collection of assets worth a dollar that could be bought for fifty cents or less. Buffett and Munger moved to value 2.0: a great business at a reasonable price, like Apple at ten or twelve times earnings, which you can hold for a long time without buying, selling, and reinvesting.
Value 3.0 and Amazon
Value 3.0 came from investors like Nick Sleep, who watched Amazon in real time in his Nomad letters. Amazon didn't look cheap on the surface. Adding back the investments it was making revealed its margin potential, and in hindsight it was one of the cheapest companies in the world, compounding at forty-seven percent from that point. Bill Miller makes the same point: value is about buying at a huge discount to what you believe a company will be worth, and that is how he came to own fifteen percent of Amazon.
Working Backward
Asymmetry runs through all three versions: where the floor is, how you lose, how a permanent loss of capital happens. Working backward from an end state makes the math concrete. A company that becomes ten times larger over ten years returns twenty-six percent a year, and a fourfold gain returns fifteen.
How did Graham's cheap-stock method work?
Benjamin Graham and David Dodd laid out the approach in Security Analysis in 1934. One of Graham's tests was the net-net: a stock trading below its current assets minus all liabilities, so the business was priced under what its cash, inventory, and receivables would fetch. Graham taught the method at Columbia Business School, where Warren Buffett studied under him around 1950.
Why did Buffett move beyond Graham's approach?
Buffett wrote in his 1989 letter to Berkshire shareholders that it is far better to buy a wonderful company at a fair price than a fair company at a wonderful price. He has credited Charlie Munger with pushing him toward that view. Berkshire's 1972 purchase of See's Candies, which earned far more than its book value implied, is the example he has cited most often.
Why did Amazon's profits look thin early on?
Amazon kept putting cash into warehouses, technology, and new businesses, which held reported profits down for years. The company reported its first full-year profit in 2003, nine years after it was founded. Jeff Bezos's shareholder letters from the late 1990s laid out the plan to prioritize long-term cash flow over near-term earnings.
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