Quantitative Value, + Web Site: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors

CHAPTER 6

Financial Strength: Foundations Built on Rock

Huge debt, we were told, would cause operating managers to focus their efforts as never before, much as a dagger mounted on the steering wheel of a car could be expected to make its driver proceed with intensified care. We'll acknowledge that such an attention-getter would produce a very alert driver. But another certain consequence would be a deadly—and unnecessary—accident if the car hit even the tiniest pothole or sliver of ice. The roads of business are riddled with potholes; a plan that requires dodging them all is a plan for disaster.

—Warren Buffett, Shareholder Letter, 19901

Buffett prizes stocks with unusual financial strength maintained through thick and thin. His frequent discussions of financial strength typically occur in the context of Berkshire's insurance operations. Buffett believes that more than simply providing protection, Berkshire's “towering” financial strength provides it with a competitive advantage. He writes that Berkshire's “premier financial strength” makes “a real difference in the competitive position of [Berkshire's] insurance operation.”2 It's so important that Buffett says, “[at] Berkshire, financial strength that is unquestionable takes precedence over all else.”3

Buffett credits Graham with teaching him the value of financial strength. Graham's view was that financial strength and the margin of safety were inextricably intertwined4:

Analysts may place primary emphasis upon the presence ...