Dipping your toes into the world of investing can be an intimidating endeavor, especially with the sheer amount of strategies and ideologies out there. Among the numerous voices, one stands out for its simplicity, wisdom, and proven success. This voice belongs to none other than Warren Buffett, one of the world’s most successful investors, known for his practical, long-term approach to investing. In this blog post, we’ll unpack some of the invaluable insights shared by Buffett, taking a deep dive into his philosophy and providing beginners with a robust framework to begin their investment journey. So whether you’re just starting out or seeking to improve your investment strategy, prepare to learn from the Oracle of Omaha himself.
Managers must have integrity and talent
It’s crucial to understand the quality, vision, and integrity of the managers and CEO of any company you invest in. Look for long track records of success and honesty before investing money anywhere. This also includes fund managers. Stay away from any accounting irregularities or known fraud.
“We look for three things when we hire people: we look for intelligence, we look for initiative or energy, and we look for integrity. And if they don’t have the latter, the first two will kill you because if you’re going to get somebody without integrity, you want them lazy and dumb. I mean, yeah, you don’t want them smart and energetic.” – Warren Buffett
Invest based on facts, not emotions
Every investor must have a quantified system with an edge for buying, holding, and selling before they ever put any money at risk in the markets. Once they have that system they must follow it with discipline and overcome the impulses of fear, greed, and ego that can cause them to break the system and lose their edge.
“The answer is that investors behave in very human ways. They get very excited during bull markets and they look in the rearview mirror, thinking ‘I made money last year. I’m going to make more money this year, so this time, I’ll borrow’. Or, the neighbor says ‘I wasn’t in last year when that neighbor, who was dumber than I, made a lot of money. So, I’m going to go in this year.’ They’re always looking in the rearview mirror. And when they look in the rearview mirror, and they see a lot of money having been made in the last few years, they plow in and push and push on prices. When they look in the rearview mirror, and they see no money having been made, they just say, ‘This is a lousy place to be.’ They don’t care what’s going on in the underlying business, and it’s astounding, but that makes for a huge opportunity.” – Warren Buffett
Buy wonderful businesses, not ‘cigar butts’
Investing is a lot easier when you buy great businesses at good fundamental prices than trying to buy bad companies in decline at very low historical prices. Look for quality and value when investing not perceived low prices. Most stock prices that are extremely low are so low for good reasons the underlying company is in decline and possibly headed toward bankruptcy.
“I’ve been taught by Ben Graham to buy things on a quantitative basis. Look around for things that are cheap. I was taught that in 1949 or 1950, and it made a big impression on me. So, I went around looking for what I call ‘used cigar butts’ of stocks. The ‘cigar butt’ approach to buying stocks is that you walk down the street and you’re looking around for cigarette butts. You find this soggy, ugly-looking cigar with one puff left in it. But you pick it up, you get your one puff, and it’s disgusting. You throw it away, but it’s free; it’s cheap. Then, you look around for another soggy, one-puff cigarette. Well, that’s what I did for years. It’s a mistake; although you make money doing it, but you can’t make it with big money. It’s so much easier just to buy wonderful businesses. Now, I would rather buy a wonderful business at a fair price than a fair business at a wonderful price.” – Warren Buffett
Only buy stocks in companies where you understand the business
Only invest in the stocks of businesses you fully understand. You need to understand the business’s financials, its competitive advantage in the market, and its sales and profit trends. Stick with a business you believe you can accurately project the business trajectory over the next decade.
“I have an old-fashioned belief that I can only should expect to make money in things that I understand. When I say ‘understand,’ I don’t mean understanding what the product does or anything like that. I mean understanding what the economics of the business are likely to look like 10 or 20 years from now. I know in general what the economics of, say, Wrigley chewing gum will look like 10 years from now. The internet isn’t going to change the way people chew gum. It isn’t going to change which gum they chew. If you own the chewing gum market in a big way and you’ve got Doublemint, Spearmint, and Juicy Fruit, those brands will be there ten years from now. So, I can’t pinpoint exactly what the numbers are going to look like on Wrigley, but I’m not going to be way off if I try to look forward on something like that. That evaluating that company is within what I call my circle of competence. I understand what they do; I understand the economics of it. I understand the competitive aspects of the business.” – Warren Buffett
When you see a great opportunity, take it
The ability to seize investment opportunities as they arise is a very profitable edge, as the best opportunities are rare and shouldn’t be missed. The skill is in identifying them in real-time as they occur. This is what Buffett is a master at.
“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” – Warren Buffett
“The biggest mistakes I’ve made, by far, are mistakes of omission and not commission. I mean, it’s the things I knew enough to do; they were within my circle of competence, and I was sucking my thumb, and that is really…those are the ones that hurt. They don’t show up any place. I probably cost Berkshire at least five billion dollars, for example, by sucking my thumb 20 years ago or close to it when Fannie Mae was having some troubles, and we could have bought the whole company for practically nothing. And I don’t worry about that if it’s Microsoft because I don’t know it. Because Microsoft isn’t in my circle of competence. So, I don’t have any reason to think I’m entitled to make money out of Microsoft or out of cocoa beans or whatever. But I did know enough to understand Fannie Mae, and I blew it. And that never shows up under conventional accounting. But I know the cost of it. I know I passed it up and those are the big, big mistakes and I’ve had plenty of them.”
“Unless I tell you about them in the annual report, and I resist the temptation sometimes, unless I tell you about them in the annual report, you’re not going to know it because it doesn’t show up under conventional accounting. But omission is way bigger than commission.”
“There’s big opportunities in life that have to be seized. We don’t do very many things, but when we get the chance to do something that’s right and big, we’ve got to do it. And even to do it in a small scale is just as big a mistake almost as not doing it at all. I mean, you’ve really got to grab them when they come, because you’re not gonna get 500 great opportunities.” – Warren Buffett
Don’t sell your stock unless the business fundamentally changes
Buffett likes to buy stocks in companies at great prices that are such great companies with a competitive advantage that he plans on holding them forever. Buffett advises investors to buy right and sit tight unless the company’s fundamentals change dramatically enough to justify selling the stock.
“Our favorite holding period is forever.” – Warren Buffett
“In terms of our wholly owned businesses, we’re not going to sell no matter how much anybody offers us for. I mean, if somebody offers us three times what something is worth, that’s See’s Candy, The Buffalo News, Borsheims, whatever it may be, we’re not going to sell it.”
“I may be wrong in having that approach. I know I’m not wrong if I owned 100% of Berkshire, because that’s the way I want to live my life. I’ve got all the money I could possibly need. It just amounts to a change in the newspaper story on my obituary and the amount of money the foundation has. To break off relationships with people I like and people that have joined me because they think it’s a permanent home, to do that simply because somebody waves a big check at me, it would be like selling one of my children because they wave a big check, so I won’t do that. And I want to tell my partners I won’t do it, so they’re not disappointed in me.”
“More and more, with certain stocks, we’ve got that approach now. If we were chronically short of funds and all kinds of opportunities coming, we might have a somewhat different approach, but our inclination is not to sell things unless we get really discouraged perhaps with the management, or we think the economic characteristics of the business change in a big way. We’re not going to sell simply because it looks too high, in all likelihood.”
Buy stocks below the company’s intrinsic value
Focus on the value of a company first then determine how accurate the price is for the valuation.
“Price is what you pay, value is what you get.” – Warren Buffett
Q&A session: “Hello, Mr. Buffett. I got two short questions. One is how do you find intrinsic value in a company?’
Buffett’s response: Well, intrinsic value is what is the number that if you were all-knowing about the future and could predict all the cash that the business would give you between now and judgment day, discounted at the proper discount rate, that number is what the intrinsic value of businesses. In other words, the only reason for making investment and laying out money now is to get more money later on, right?”
“That’s what investing is all about. Now, when you look at a stock, when you look at a bond, US government bond, it’s very easy to tell what you’re going to get back. It says it right on the bond, when you get the interest payments when you get the principal. So, it’s very easy to figure out the value of a bond. It can change tomorrow if interest rates change, but the cash flows are printed on the bond.”
“The cash flows aren’t printed on a stock certificate. That’s the job of the analyst: to change that stock certificate, which represents an interest in the business, into a bond and say, ‘This is what I think it’s going to pay out in the future.”
“When we buy some new machine for Shaw to make carpet, that’s what we’re thinking about. And you all learn that in business school, but it’s the same thing for a big business. If you buy Coca-Cola today, the company is selling for about $110 to $115 billion in the market. The question is: if you had $110 or $115 billion, you wouldn’t be listening to me, but I’d be listening to you, instead.”
“The question is, would you lay it out today to get what the Coca-Cola company is going to deliver to you over the next two or three hundred years? The discount rate doesn’t make much difference as you get further out, but that is a question of how much cash they’re going to give you.”
“This isn’t a question of how many analysts are going to recommend it, or what the volume in the stock is, or what the chart looks like, or anything. It’s a question of how much cash it’s going to give you. That’s your only reason. It’s true if you’re buying a farm, it’s true if you’re buying an apartment house. Any financial asset, oil in the ground, you’re laying out cash now to get more cashback later on. And the question is: how much are you going to get, when are you going to get it, and how sure are you?”
“When I calculate the intrinsic value of a business, whether we’re buying all of a business or a little piece of a business, I always think we’re buying the whole business because that’s my approach to it. I look at it and say, ‘What will come out of this business, and when?’ What you really like, of course, is for them to be able to use the money they earn and earn higher returns on it as you go along.”
“Berkshire has never distributed anything to its shareholders, but its ability to distribute goes up as the value of the businesses we own increases. We can compound it internally. But the real question is: Berkshire is selling for, we’ll say, $105 billion now. If you’re going to buy the whole company for $105 billion now, can we distribute enough cash to you soon enough to make it sensible at present interest rates to lay out that cash now? And that’s what it gets down to.”
“And if you can’t answer that question, you can’t buy the stock. You can gamble in the stock if you want to, or your neighbors can buy it. But if you don’t answer that question… I can’t answer that for internet companies, for example. There’s a lot of companies, all kinds of companies I can’t answer for. But I just stay away from those.” [1]
Key Takeaways
- Emphasize understanding over-diversification: In Buffett’s philosophy, a deep comprehension of a business trumps the conventional wisdom of broadening your investment portfolio.
- Stick to what you know: Rather than chasing every potential opportunity, Buffett encourages investors to stay within their “circle of competence,” investing in industries and companies they truly understand.
- Acknowledge the power of patience: Successful investment requires discipline and time, favoring long-term gains over quick, short-term wins.
- Value over hype: The core of Buffett’s approach is buying fantastic businesses at fair prices, not just ‘fair businesses at wonderful prices.’
- Size can limit performance: Particularly relevant to investment funds, as they grow, they may struggle to maintain their performance due to difficulties in managing sizable investments.
- Seize significant opportunities: While Buffett’s strategy is often characterized by caution and patience, he advises seizing significant the right opportunities when they come.
Conclusion
Warren Buffett’s investing ethos, while simple to comprehend, requires an unwavering commitment to discipline, comprehension, and patience. He champions the idea of focusing one’s investments on industries and businesses they thoroughly understand, stressing the value of patience and the potential of long-term investments. Instead of encouraging diversification as a safety net, Buffett propounds the principle of knowledge as the true protector against investment risks. Moreover, he underscores the limitations that size can impose on performance, specifically within the context of investment funds. Amid these, his mantra remains clear – seize the right significant opportunities when they present themselves, highlighting his balanced approach of cautious patience and bold moves. His investment philosophy, while not necessarily straightforward to implement, provides an enlightening perspective for beginners in the investment world.
