Warren Buffett is generally credited as the most successful investor of all time. But those seeking to learn from him must recognize that there have been distinct phases in his investing career. And we are seeing his next evolution play out right now.

Buffett is famous as a value investor, for paying cheap prices for stocks. This image comes from Buffett’s initial investment philosophy built around the teachings of Ben Graham. Graham had become an investor during the Great Depression and he recognized that some stocks were so cheap that no matter how badly the companies performed fundamentally, the stocks could still do well. These sorts of opportunities became far more rare in the years after World War II, when Buffett was a young investor and so his thinking evolved to incorporate the philosophies of growth investor Phil Fisher. Buffett was also strongly influenced by his partner Charlie Munger’s thinking that some growth companies could be bought at “fair” rather than cheap prices.

“It’s far better to buy a wonderful company at a fair price than a fair  company at a wonderful price. Charlie understood this early; I  was a slow learner.” Warren Buffett, Berkshire Hathaway 1989 annual letter

This evolution from a Ben Graham value investor to a Fisher/Munger quality focused investor is fundamental to understanding Buffett’s legacy. It highlights that Buffett’s advice is not about a formula or set of rules that are set in stone. Instead, they are context specific. In the wake of the Great Depression, you could buy stocks for less than the net cash on the company’s balance sheet and a valuation-first philosophy made sense. But over the last 50 years, a quality-first approach (with a continued appreciation for not overpaying for quality) has been a much better fit for the economic and market environment.

One of the key things that Buffett has looked at during this phase of his investment career has been companies that have an opportunity to re-invest a lot of capital at attractive rates of return.

“The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns.” -Warren Buffett, 2003 Berkshire Hathaway Annual Meeting

But now, Buffett has pointed to something new. Something so important that even though it was reported on in real time, he thinks people didn’t appreciate enough the importance of his comments.

“I believe that probably the five largest American companies by market cap…they have a market value of over two-and-a-half trillion dollars…and if you take those five companies, essentially you could run them with no equity capital at all. None.” -Warren Buffett, 2017 annual meeting.

Buffett went on to call these “ideal businesses”, the same phrase he used in the past to refer to companies that reinvested massive amounts of capital at high returns.

Then, the next day in a CNBC interview with Becky Quick, Buffett referenced these comments again saying “I did mention one thing at the meeting, which I don’t think people appreciated at all… So you have close to 10% of the market value perhaps of the United States in five extremely good businesses that essentially take no capital. Now that was not the case in the past.”

The “five extremely good businesses” that Buffett is talking about are Apple, Microsoft, Amazon, Google and Facebook (Buffett is quick to remind the interviewer to include Facebook in the list when she leaves it out initially). Then, when Quick asks him “Would you like Berkshire’s businesses to be more reflective of that sort of new paradigm?” Buffett says “I’d love it.”

Apple, Microsoft, Amazon, Google and Facebook. That’s Warren Buffett’s idea of what he’d like to see Berkshire Hathaway’s portfolio look like going forward. These are the new “ideal” businesses in his view.

If that statement doesn’t reflect a new phase in Buffett’s investing career, I don’t know what would.

But it is important to note this isn’t a rejection of the past, it is an evolution in his thinking that is entirely philosophically consistent. In fact, one good way to understand the evolution is using Connor Leonard’s moat framework that we discussed in a recent post. Buffett is just moving his focus from “reinvestment moat” businesses to “capital light compounders”.

Buffett’s genius doesn’t rest on some key insight he discovered long ago. Buffett’s genius is that he is a life long learner. He recognizes his mistakes and learns. One of those mistakes was not investing in Google, which Charlie Munger declared at the meeting should have been “easy” and that they “screwed up” not investing in the company. But then Munger, teasing Buffett, says the key thing that has made Buffett great:

“I think it’s a very good sign that you bought the Apple stock,” Munger told Buffett. “It shows either one of two things: Either you’ve gone crazy or you’re learning. I prefer the learning explanation.”

Ensemble Capital’s clients own shares of Apple (AAPL) and Alphabet (GOOGL).

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