What is Cigar Butt Investing?

 

Warren buffet, the guru of value investing is known for his wit and wisdom, but his real greatness comes from the fact that he never shies away from owning his mistakes and sharing that knowledge with the rest of the world. One of the mistakes, which he interestingly calls the Cigar Butt Investing is important from an investment perspective. Here is how he describes it.

A person with no money is walking down the street. When he sees a discarded cigar, which is not completely used and some of the portion is still left, he picks it up, lights it and enjoys a few puffs and moves on. It might not be as gross and disgusting as it may sound. There was a risk-free opportunity and this person took advantage of that.

This, in fact, is the same approach that Benjamin Graham, Warren Buffett’s mentor and Warren Buffett himself followed in investing for several years. They used to look for distressed companies that were valued well below their actual value and then used to buy them at bargain prices. The idea was very simple. If the business recovered, they would make a lot of money, but even if it did not, the value of all the assets at the time of liquidation would be higher than what they would have paid.

Hence they would still end up making money. In other words, their cigar butt still had a few free puffs left into it. In the world of investing, there is another fancy name for this approach. It is called deep value investing and a recent example of that is when the telecom company Idea Cellular was on the brink of bankruptcy.

The stock of Idea Cellular was trading somewhere around 2 or 3 rupees. So some deep value investors bought Idea Cellular at this point because the intrinsic value of the business was greater than the stock price at that time. However, as Warren Buffet learned later in his career, Cigar Butt approach is not as great as it sounds.

First of all, it doesn’t work as well as it used to because the regulatory climate has changed. When Benjamin Graham started this approach some 50 or 60 years ago, the regulatory climate was different. Assume that a company did go for liquidation. They could keep the cash after selling all their assets and settling the liabilities.However, in today’s environment, the government has made that much harder.

The second reason why Warren stopped Cigar Butt investing is that he realized that he could not invest a lot of money in such distressed companies. Going back to the same example of Idea Cellular, even if you saw deep value investing opportunities in Idea, would you be willing to put 1 or 2 crore rupees in this stock? No, you would not be willing to take that kind of risk.

The third and the most important reason, as Warren Buffett elegantly put it is that time is friend of a good business and enemy of mediocre ones. What Warren Buffet realized was that it was better to pay a high price for a great company than paying a low price for a mediocre company.

This is the reason why Warren Buffett stopped doing Cigar Butt Investing and stopped looking for these bargain opportunities in failing companies. I hope that after watching this video, you will also learn from this legendary investor and avoid picking cigars on the streets, just to get a few free puffs.

Warren buffet, the guru of value investing is known for his wit and wisdom, but his real greatness comes from the fact that he never shies away from owning his mistakes and sharing that knowledge with the rest of the world. One of the mistakes, which he interestingly calls the Cigar Butt Investing is important from an investment perspective. Here is how he describes it.

A person with no money is walking down the street. When he sees a discarded cigar, which is not completely used and some of the portion is still left, he picks it up, lights it and enjoys a few puffs and moves on. It might not be as gross and disgusting as it may sound. There was a risk-free opportunity and this person took advantage of that.

This, in fact, is the same approach that Benjamin Graham, Warren Buffett’s mentor and Warren Buffett himself followed in investing for several years. They used to look for distressed companies that were valued well below their actual value and then used to buy them at bargain prices. The idea was very simple. If the business recovered, they would make a lot of money, but even if it did not, the value of all the assets at the time of liquidation would be higher than what they would have paid.

Hence they would still end up making money. In other words, their cigar butt still had a few free puffs left into it. In the world of investing, there is another fancy name for this approach. It is called deep value investing and a recent example of that is when the telecom company Idea Cellular was on the brink of bankruptcy.

The stock of Idea Cellular was trading somewhere around 2 or 3 rupees. So some deep value investors bought Idea Cellular at this point because the intrinsic value of the business was greater than the stock price at that time. However, as Warren Buffet learned later in his career, Cigar Butt approach is not as great as it sounds.

First of all, it doesn’t work as well as it used to because the regulatory climate has changed. When Benjamin Graham started this approach some 50 or 60 years ago, the regulatory climate was different. Assume that a company did go for liquidation. They could keep the cash after selling all their assets and settling the liabilities.However, in today’s environment, the government has made that much harder.

The second reason why Warren stopped Cigar Butt investing is that he realized that he could not invest a lot of money in such distressed companies. Going back to the same example of Idea Cellular, even if you saw deep value investing opportunities in Idea, would you be willing to put 1 or 2 crore rupees in this stock? No, you would not be willing to take that kind of risk.

The third and the most important reason, as Warren Buffett elegantly put it is that time is friend of a good business and enemy of mediocre ones. What Warren Buffet realized was that it was better to pay a high price for a great company than paying a low price for a mediocre company.

This is the reason why Warren Buffett stopped doing Cigar Butt Investing and stopped looking for these bargain opportunities in failing companies. I hope that after watching this video, you will also learn from this legendary investor and avoid picking cigars on the streets, just to get a few free puffs.