Paying $80 for a $100 note… sounds too good to be true. Yet, that's essentially how Warren Buffett made market-beating returns early in his investing career. Do these opportunities still exist among Australian companies? I believe so… and I've found what could be the top ASX stock to buy for this 'deep value' approach.
The $788 million company is a candidate for the legendary billionaire's old investment strategy, but it also might be an improvement. While most of Buffett's picks under this approach were good for a quick buck, this S&P/ASX All Ordinaries Index (ASX: XAO) company could have long-term legs.
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Warren Buffett's highly profitable, old-school strategy
You might be wondering… what is the investing strategy that the co-founder of Berkshire Hathaway Inc (NYSE: BRK.A) (NYSE: BRK.B) used to apply—and if it were so good, why is it the old Warren way? Wouldn't the great Buffett still be putting it to work?
Well, the approach is referred to as 'cigar butt investing'. It's a value investing strategy at its core. You want to find a company that has been discarded — like a cigar butt — that still has more puffs of smoke in it. In other words, the company still has more value than investors give it credit for.
Looking at a business's book value is a simple way to identify companies that may fall into this category.
In a worst-case scenario, a business can be liquidated, selling its assets to erase debts and provide any leftover case to investors. A company's book value can roughly estimate its liquidation value. A price-to-book (P/B) ratio below 1 might indicate that there's some value to be realised.
How profitable was this way of investing for Buffett? Take a look for yourself at the returns under the Buffett Partnership compared to the Dow Jones below:
| Year | Buffett Partnership | Dow Jones |
| 1957 | 10.4% | -8.4% |
| 1958 | 40.9% | 38.5% |
| 1959 | 25.9% | 20.0% |
| 1960 | 22.8% | -6.2% |
| 1961 | 45.9% | 22.4% |
| 1962 | 13.9% | -7.6% |
| 1963 | 38.7% | 20.6% |
| 1964 | 27.8% | 18.7% |
| 1965 | 47.2% | 14.2% |
| 1966 | 20.4% | -15.6% |
| 1967 | 35.9% | 19.0% |
| 1968 | 58.8% | 7.7% |
The Oracle from Omaha closed down this fund after 1968. Buffett later justified this by saying the fund had become too large to find cigar butt investing stocks big enough to move the needle at its size. However, that shouldn't be an issue for people like you and me — unless you've won the lotto…
ASX stock to buy with plenty of puff
Rural Funds Group (ASX: RFF) is a perfect candidate for cigar butt investing. The Australian real estate investment trust (REIT) owns a mix of agricultural assets across the country and trades on a P/B ratio of 0.7 times book value.
As I said, this company is valued at nearly $790 million. Yet Rural Funds Group holds $1.045 billion in net assets when you subtract the liabilities. In my opinion, this suggests a straightforward path to a 32% upside for this ASX stock.
It's not without its risks. The value of its properties can fluctuate depending on weather conditions, natural disasters, and leasing arrangements. However, land is in high demand and short supply. As such, I'm confident land prices are more likely to appreciate than depreciate.
Lastly, I think this top ASX stock to buy is better than a traditional cigar butt pick because of one key reason…
Buffett was looking for one puff to boost a company's share price before offloading. In contrast, I believe Rural Funds Group could be the cigar that keeps on giving in the long run. Developing and managing land for various intensive activities is critical. Rural Funds has the know-how and capital to keep acquiring land and adding value.
