Warren Buffett, PetroChina and the safety margin

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– Through

Warren Buffett (Trades, Portfolio) has always tended to stay away from overseas assets because he does not understand the rules and regulations that govern markets in different countries. However, that does not mean that he completely avoided investing in foreign stocks.

Buffett invests in China

One of Buffett’s overseas investments was PetroChina (NYSE: PTR). According to comments from the Oracle of Omaha, he bought this stock in the early 2000s. At the Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) annual shareholders meeting in 2005, he said it was the first Chinese stock the conglomerate has ever acquired. He deployed around $ 400 million in the opportunity, making him a significant owner of the business at the time.

Based on his comments from 2005, Buffett had made a relatively simple calculation. He could see that this company was making $ 12 billion a year and producing 3% of the world’s oil. The Oracle also noted:

“In the annual report, they say something that very, very few companies say, but which I think is actually quite important. They say they will pay about 45% of the amount they earn.”

He added :

“So if you can buy it at three times the profit, which turned out to be three times the profit, and you get 45%… you get a 15% cash return on your investment.”

The safety margin

This is a classic “face I win face I don’t lose much” style investment. PetroChina was really cheap, and that valuation made up for some of the uncertainty Buffett would have encountered when buying a foreign company.

This is Benjamin Graham’s safety margin in action. Buffett bought the stock at a very low price, which leaves a lot of room for mistakes. Even if he thought the business was worth nine times the profit and was down 50%, that would still represent a 50% gain on the purchase price, excluding any income received.

And even if the stock didn’t budge, if it paid 15% dividends per year, any investor who bought PetroChina in the early 2000s would have done very well.

In his book “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor”, Seth Klarman (Trades, Portfolio) noted:

“A margin of safety is achieved when securities are purchased at prices sufficiently below the underlying value to allow human error, bad luck or extreme volatility in a complex, unpredictable and rapidly changing world. “

I couldn’t think of a better way to sum up Buffett’s job. He may not have understood all the intricacies of the Chinese financial and political system at the time, but the safety margin available on stocks was so large that it sufficiently compensated him and the shareholders of Berkshire. , for uncertainty.

This is something investors may want to keep in mind when investing overseas or in sectors or industries that they are not particularly familiar with. Having a large safety margin can compensate for lack of knowledge, although it should never be used as a substitute. Further research is the easiest way to reduce your risk.

Yet, even if you’ve done your research, you can’t factor in the unknown unknowns. This is where the safety margin comes into its own.

This article first appeared on GuruFocus.

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