Five lessons from Buffett the master
Human evolution is an amazing process but it has delivered some downsides, particularly for investors.
Take, for example, how we process information. We regularly slice through limited information and draw quick conclusions to complex questions. Our brains do this by drawing heavily on prior experience. That’s great if this experience is based on solid facts, but it leads to some spurious conclusions if it isn’t.
Commonly referred to as bias, it’s rife in the world of investing. For proof, look no further than the multitude of disparate and often conflicting views held by any sample of investment “experts”. What they claim to be definitive investment wisdom is about as consistent as Melbourne’s weather.
Faced with writing an article on investment principles, I’ve chosen to play it safe: I’m not claiming the following views as my own, rather as those of a man who investors worldwide acknowledge as one of the most logical and successful investors ever – Warren Buffett.
Yes, it’s Buffettisms time again
I know what you’re thinking – please, no more Buffettisms, I’ve heard them all before.
Yes, I know he likes companies with low or no debt, that deliver a high return on equity, that have a “moat” around their business operations (to help protect against the onslaught of competition) and they are run by honest and capable management. And I nearly forgot, they are also selling for a cheap price.
Just like many of you, I’ve read all that stuff in books. But reading hasn’t stopped me from travelling to Omaha for five consecutive years to attend the AGM of Berkshire Hathaway, the company Buffett has led for the past 51 years.
It has been well worth it because it has given me the opportunity to hear Buffett speak on a variety of investing topics – for a total of more than 20 hours. It has also allowed me to interact directly with the CEOs of some of Berkshire’s fully owned subsidiaries, to meet with friends of Buffett and even to chat with one of his three children.
But the biggest payoff from my visits to Omaha is that it has hammered home the principle that successful investing is not rocket science. Rather, it relies on the consistent application of some basic investment truths.
Let’s look at five of Buffett’s investment truths that the books have devoted few words to.
1. Patience brings rewards
Patience is a word that crops up throughout financial history as a characteristic common to the world’s greatest investors. At a small Omaha gathering I attended a few years back, Buffett’s daughter, Suzie, was asked by the gentleman sitting next to me, “What qualities best describe your father?” Suzie did not hesitate: “Integrity and patience.”
Buffett has both in spades. He has earned his patience tag because money never burns a hole in his pocket. Rather, he sits on a large war chest of cash waiting for investment opportunities to come his way. Berkshire currently has US$53 billion in “readies”, just waiting for the next opportunity.
2. It’s about effort, not genius
Many imagine that Buffett’s success relies on some secret investing technique or magic valuation formula that only he possesses. Neither is the case. His success relies on application. He has devoted his life to a deep understanding of business models.
It means he can quickly identify opportunities when they arise by drawing on his solid, deep (and logical) knowledge base. It’s no different to the success one can attribute to an elite sportsman or entertainer. Observers see the success, but never the hard work that led to it.
3. It’s not the formula that matters; it’s the inputs
Buffett uses the same formulas others do. What separates him is his inputs into the formulas. It’s also interesting to note that the valuation formulas he uses are simple ones. This is clearly demonstrated by the absence of a computer or calculator on his office desk. Instead, his desk is littered with copious volumes of reading material.
4. Ditch the crystal ball
Many believe that investing success is dependent upon superior powers of prediction. It might surprise you to know that Buffett ignores the predictions of “market experts”, doesn’t employ any economists at Berkshire, nor does he pay any attention to those economists that he doesn’t employ.
To quote him directly: “Forecasts may tell you a lot about the forecaster; they tell you nothing about the future.”
5. Finally, the three Cs
a. Corporate compounding. Buffett is a fan of the late, great economist, John Maynard Keynes (Keynes’ investment success didn’t rely on economic forecasting either). In his famous 1936 book, The General Theory, Keynes reminds us that stock prices are driven by two main forces – business enterprise and market psychology.
While profits (and the dividends that follow) are closely aligned with business enterprise, the capital gains (which come from gains in stock prices) are a product of both enterprise and market psychology. Reflecting Keynes’ views, Buffett prefers to measure success by growth in Berkshire’s book value rather than by growth in its stock price.
You should also embrace this enterprise focus when investing. Many investors seem to forget that there is actually a company under that share price.
b. Consistency. Share markets love the latest thing, whether it’s a dot.com revolution or a mining boom that punters reckon will last forever. Investment fads come and go but Buffett’s investment principles have remained consistent throughout the years.
I recall a December 1999 article in the Australian Financial Review with the headline, “Buffetted by the winds of change.” It posed the question: “Is Buffett losing his touch.” At the time, Buffett was staying right out of the dot.com comedy and Berkshire’s stock portfolio was suffering (if measured in terms of the market prices of the stocks it held).
Despite mounting criticism, Buffett remained true to his long-held beliefs. He wasn’t about to compromise his investing principles to suit current fashion. Time showed his was the correct course to take. In the wake of the dot.com crash, Berkshire (which owned real businesses) powered ahead while most of the dot.com duds evaporated into thin air.
Consistency is a common characteristic among successful investors. Market writer, Garfield Drew, recognised this when several decades ago he wrote: “In fact, simplicity or singleness of approach is a greatly underestimated factor of market success.”
c. Culture. Berkshire Hathaway is a huge company by any measure – a market capitalisation of US$350 billion, about 90 fully owned subsidiaries, and more than 360,000 employees. Despite this, Buffett, as Berkshire’s CEO, pays himself a small, but sufficient, salary of US$100,000 a year.
In terms of remuneration, he also dislikes the now common corporate practice of gifting options and shares to senior management. If Berkshire’s top brass want to own Berkshire stock, they have to buy it with their own money, just like everyone else.
Buffett also likes to treat Berkshire shareholders as his partners. When reporting to them in the annual report, his communication style is transparent and open.
So what’s the take-home message regarding culture? Buffett looks for the same characteristics of integrity and transparency in the people running the businesses that he invests in.
If his investing track record is anything to go by, so should you.
About the author
Michael Kemp is chief analyst at The Barefoot Blueprint.
Michael Kemp is chief analyst at The Barefoot Blueprint.
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