The company would have a reserve for their expected costs of the suit. If they reserved $200M, then they would have a negative net worth. As an investor you should make your own estimates as well.

Your assuming the company know about this, and it's public information, both of which add quite a bit of lag time and thus investor risk.

Assessing risk is an important part of valuing companies. Lawsuits usually don't materialize out of thin air, and when they do, they usually aren't very strong cases.

One great historical case for Buffett was the Salad Oil Scandal. American Express stock plummeted because it had guaranteed loans backed by salad oil inventories that turned out to be fraudulent. It was facing a huge loss for the time, some were even afraid it might go out of business.

But Buffett went to lunch and saw customer after customer still using Amex cards to pay for their meals. He realized that the charge card part of Amex was still really valuable, and did the math on what the credit card business was worth and their maximum possible losses from their loans would be, and realized the stock was hugely undervalued and bought a ton.

Every business has remote risks of crazy bad things happening, it's why you diversify your portfolio if you are an active investor.

Most value investors you've heard of aren't really value investors, they're activist hedge fund managers who try to "catalyze the unclaimed inherent value" in a company by bullying them (through board seats) to course-correct the company...or they're a fund that's trying to match the market rather than beat it (most mutual funds), because they're so risk-averse or have such a poor strategy that they don't have faith it will work.

Yeah I've never understood how value investors account for hidden liabilities. Perhaps you have to be very good at reading financial statements.

As valuearb pointed out, value investing basically comes down to reading 10Ks and 10Qs which are freely available on the SEC database. You read those to get the complete financial health of a company, and using those numbers, calculate what you believe to be the fair value of a company.

"Well if it's a belief, then isn't value investing just as much speculation as anything else?"

That's where the term Margin of Safety comes in. The financials of a company provide a delta, some min and max of where the company can go. When you plug in your estimates, and that delta's minimum is still less than the current price of the stock, esp by a significant margin, then you've picked a winner...more specifically, a winner over the next few years. Remember, plenty of events can occur between now and when your value is realized, and one of the other traits of a strong value investor is the ability to weather the storm. Oftentimes these companies with sufficient margin of safety will continue to fall in price before they rise again, one cannot time the market for the zenith nor the nadir of a stock's price.

Public companies are required to report on all of their liabilities. You read the quarterly and annual reports and intelligently assess which risks are significant or not, and how to discount for them.

Beyond that you spend time thinking about their business and what could go wrong. If there is something obvious to you they didn't disclose, that would tend to mean management is untrustworthy or incompetent, two other huge risks.

Buffett spends lots of hours reading reports away from CNN and computers and distractions. I'm sure he talks to Charlie and others regularly about things that concern him and gets different perspectives.

Again, a lot can happen in a week let alone 3 months between annual reports. The secret of Buffet's success is not limited to value investing he had quite a bit of early leverage and of course is also quite old now which give plenty of time to compound gains.

It's difficult to compound gain at 19% for 50 years--the S&P only did 10%. The secret of Buffett's success, which he explains in every letter, is that he bought an insurance company. As long as you are diligent in writing non-money-losing policies, you get the premiums up front and pay later. So you have all this float that you can do something with. But he also picks good companies, picks good managers, and is careful to make sure that the financial incentive for the manager is the same as the financial incentive for Berkshire, which is not the case with most executive packages.

Exactly, leverage happened to work out really well for him, but true big the same idea can easily end up with you broke.

Nope.

Leverage is only minor component of his late career success, and insurance float could never have gotten him broke. It's totally unlikely like a loan from your broker.

His late career has been less impressive vs is early career. Also, float can dry up if insurance sales drop. So in many ways it's worse than a loan from your broker it's got totally random size fluctuations. He just happened to be really lucky / skilled at running an insurance company over time so that this was not an issue. However, that says more about running an insurance company than investing.

If his results declined after he bought insurance companies, how does that say he was lucky/skilled at running them, and how did he gain any benefits from the leverage they afforded?

The reality is his late career is less impressive only in one way, annualized returns, and it's more impressive in virtually every other way. He started out with less than a million in investors money, and his 40% returns with the Buffett Partnership were probably with an average of $10M to $20M total.

Nowadays his public stock portfolio was $122B at year end 2016. That limits the stock market investments he can make to a tiny fraction of stocks. He's not going to buy hundreds of stocks, not even dozens. He wants to focus in his dozen or so best ideas. So he want to be able to put $10B to work in each and there are very few public companies with market caps and trading volumes large enough to allow him to do that. So problem #1 is that he went from a market of 5,000+ stocks he could choose from to maybe a few hundred, reduced opportunities that directly hurts his returns.

Worse, how can he accumulate $10B worth of a company before he's forced to publicly disclose his purchases. If he's forced to disclose prematurely, his future returns dwindle due to free-riders driving the purchase price up before he's done. That's big problem #2.

The fact that he's still beating the market carrying these heavy chains is more impressive to me than the fact he whipped it at 3x higher rates when he could buy anything he wanted.

But, take out those 40% years and his returns are much closer to the stock indexes.

While managing billions at minimal risk he is not making nearly 17% returns. He is doing OK but again your looking at a statistical outlier so you can't separate skill and luck as much as you might think.

His returns from Berkshire Hathaway has averaged 19% over the last 52 years (from 1965), vs a 9.7% market return over the same period.

His 40% returns were in the Buffett Partnerships, which ran for 12 years from mid 50s to late 60s, and aren't counted in Berkshires results.

Doubling the market return rate over 52 years is huge outperformance. For an investor it's roughly doubling every 3.5 years instead of 7.5 years.

Add in the fact he crushed the market by nearly 4x a year for an earlier 12 years and his immense skill is undeniable. He would be statistically implausible if the world had trillions of investors.

Not sure what you mean by early leverage given he used virtually no leverage throughout his career. Insurance float is basically the only form he's used and didn't start that until the middle of his career.

His annualized returns running the Buffett Partnerships with zero leverage were close to 40% per year for the dozen or so years they were operating.

And everyone compounds gains just by holding index funds for long periods. Buffett compounds them far faster because he has substantially higher returns than the market.