March 17, 2009
When you mention Benjamin Graham, Warren Buffett, and value investing in the same conversation, you're likely to get everyone nodding and going along with what you say. That's because agreeing with a philosophy is the easy part. But actually understanding and applying the approach of that philosophy is another story.
Aside from what he's currently buying and selling, Buffett has no investment-related secrets. If you read Graham's The Intelligent Investor and Security Analysis, along with everything Buffett has written, and then work on truly understanding and applying their principles to investing, you should be able to outperform the vast majority of investors.
Graham sums up how to invest intelligently when he says, "Investment is most prudent when it is most businesslike." Apply that reasoning to your investment considerations, and you will already have a head start. But to elaborate on that idea, let's turn to some words of wisdom from the Oracle of Omaha himself.
"I am a better investor because I am a businessman and a better businessman because I am an investor."
Running a business and making an investment go hand in hand. It's that simple. You wouldn't buy a business based only on rapidly increasing profits, nor should you invest in a company on that one metric. Instead, the prudent businessperson and the intelligent investor would scrutinize the balance sheet and determine, for example, whether earnings growth has been coming at the expense of increased receivables as a result of poor credit policy. Furthermore, as any businessperson realizes, earnings are easily manufactured, whereas cash is real.
Buffett's 1973 investment in Washington Post (NYSE: WPO) is a wonderful example of a businesslike approach to investing. The idea was simple. The Post owned a wonderful collection of media assets that Buffett concluded were worth about $400 million. The company, meanwhile, was selling for just $80 million. Was it a great business? Yes. Was there a satisfactory margin of safety? Yes. Case closed.
"Never ask a barber if you need a haircut."
Here, Buffett was alluding to investment bankers and analysts. Let's face it: These folks get paid when you buy what they're selling. To be fair, there are many excellent investment bankers and analysts who truly offer a valuable service. Buffett's illuminating point was that you already know the answer you're going to get, and it will be determined by everything but rationality.
"I don't try to jump over 7-foot hurdles: I look for 1-foot hurdles that I can step over."
Buffett's critical advantage over the pack is that he focuses on the boundaries of his circle of competence rather than the size of his circle -- although his is still probably bigger than most. It's illuminating that one of the most talented investment minds of our time made the bulk of his fortune through businesses such as insurance via GEICO, soft drinks via Coca-Cola (NYSE: KO), candy, razor blades, and a host of others that are simple to understand.
"We don't get paid for activity, just for being right. As to how long we will wait, we'll wait indefinitely."
Buffett has always said you should never allow the stock markets to guide you, because the market is really there to serve you. One of Buffett's greatest attributes is that he can be patient about investments until the time is right, regardless of how long that time may be. In one case, Buffett waited nearly four years to make a significant move -- in 1970, he folded his partnership and made virtually no public-market investments until 1974, when the price-to-earnings ratio of the S&P went from around 20 to 7. At that point, Buffett began buying all over the place.
During that time, Buffett became famous for saying, "I was selling stocks at three times earnings to buy stocks at two times earnings." The approach worked: Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) shares rose from $40 to $420 per share from 1975 to 1980, for about a 57% annual rate of return!
More recently, despite having put billions into General Electric (NYSE: GE) and Goldman Sachs (NYSE: GS) preferred shares, as well buying debt of Harley-Davidson (NYSE: HOG) and Tiffany, Berkshire still has a huge cash hoard. Still, waiting for a better deal is something he has successfully done time and time again.
"When a management team with a reputation for brilliance joins a business with poor fundamental economics, it is the reputation of the business that remains intact."
A truly great business can survive with mediocre management. You should always consider that at some point, less-than-stellar management will find its way to the helm of any business.
It pays to listen closely to anything and everything Warren Buffett has to say on business and investing.
"You should invest like a Catholic marries -- for life."
When investing, you should look for businesses strong enough to endure for decades. And just as with marriage, you should be sure that this particular investment is better than any other alternative. If you invest with this lifelong approach, you will begin to focus on the important attributes of the business, rather than concerning yourself with insignificant hiccups. Buffett never concerns himself with a business's temporary setbacks, as long the important factors -- good management, low capital requirements, and durable economic advantages -- remain intact.
"You should invest in businesses that a fool can run, because someday, a fool will."
We're talking about small-f fools here, of course. A really good business will be able to withstand the poor decision-making of incompetent management. Every business life cycle will undoubtedly contain periods of superior and inferior management alike. Coca-Cola (NYSE: KO) was doing fine before the legendary Roberto Goizueta took the helm, and thereafter the company skyrocketed. Yet Coke is a sufficiently remarkable and simple business to do well without superstar management. Ironically, Buffett's Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) should also do just fine without Buffett at the top. Buffett is truly extraordinary, and over the years, he's worked to ensure that Berkshire will manage just fine after he departs.
"My idea of group decision-making is to look in the mirror."
Long-term success in investing requires the ability to go against the herd. Buffett's best investments have come at some of the direst moments in a company's history. If Buffett had relied on public opinion, he would have never invested in Berkshire Hathaway, American Express (NYSE: AXP), or GEICO -- nor, more recently, in Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE).
It's extremely difficult to invest when all the "smart money" is going against you. Buffett, unlike most investors, possesses an unwavering conviction and discipline when making investment decisions. He learned this trait at age 11, when he made his first investment of three shares of city services. After he bought the stock, the price dropped. Buffett sweated it out and sold for a small gain. Shortly thereafter, the stock skyrocketed.
"You pay a very high price in the stock market for a cheery consensus."
If you let Mr. Market guide you, you'll pay a costly price indeed. As we now know all too well, the market overcharged many for the investment du jour last year, but what went up had to come down, and vice versa. A couple years ago, many thought Google (NYSE: GOOG) was going to the moon. Yet its dramatic 60% drop from its 2007 highs prove that those who followed the crowd paid up and suffered. It's best to use Mr. Market to serve you, not guide you.
"If you lose money, I will be understanding. If you lose our reputation, I will be ruthless."
That's what Buffett told the staff of Salomon Brothers during the Treasury securities scandal in 1991. It's also what Buffett tells his managers: Berkshire can afford to lose money, but not an ounce of reputation. In business and life, your reputation is the most important attribute. Buffett's reputation for integrity is so unquestionable that he's often sought out as the buyer of choice for companies seeking a good home. Buffett has earned his reputation over the past 50 years, and he's acutely aware that it would only take seconds of poor judgment to destroy that reputation.
Lessons for corporate America
Lawrence Cunningham has assembled a wonderful book: The Essays of Warren Buffett: Lessons for Corporate America. Buffett himself has stated that it's one of his favorites, since the book is a compilation of Buffett's direct words. Even the Fool has a quote on the back, praising the book as "one of the top investment books of all time." Cunningham does a masterful job of collating some of Buffett's best philosophies, making his book -- and Buffett's words -- an excellent tool for any serious investor.
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