In this summary, you will learn
How Warren Buffett measures his investment performance,
How he spots undervalued companies and
How he has prospered.
Warren Buffett never wrote a textbook on investing, but his letters to his partners in the 1960s provide a roadmap to his thinking.
Buffett got his start investing on behalf of his family and friends.
He began in 1956 with $105,000; in a few years, his fund grew to more than $7 million.
Buffett cared about his relative performance, not his overall performance – he aimed to beat the Dow.
He was a disciple of Ben Graham, the bargain-hunting godfather of value investing.
“Soggy cigar butts” – companies with ugly business models but hidden value – were Buffett’s favorite targets.
A mapmaker and a farm equipment manufacturer were among the unloved companies the Oracle of Omaha found worthy of investment.
Buffett eventually outgrew the cigar butt strategy; he came to prefer quality companies over cheap ones.
He bought into blue-chip companies such as American Express and Disney.
The fundamentals of Buffett’s approach have changed little over the decades.
The Early Days of the Master
“We don’t buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do.” (Warren Buffett)
“I think people would be better off if they had only 10 opportunities to buy stocks throughout their lifetime.” (Warren Buffett)
Presaging his now-famous annual letter, Buffett’s correspondence with his early partners was folksy and insightful. Buffett never wrote an investment guide. These letters make up the closest thing investors will ever have to a Buffett textbook on investing. Among Buffett’s early tenets:
Performance is relative – Buffett aimed to beat the Dow, which he referred to as his “yardstick.” If the Dow fell 10% in a given year and Buffett’s investments were off only 5%, he considered his performance a victory. He promised not to celebrate a 20% gain if the Dow posted 25% for the year. He told his partners he welcomed criticism for the “right reason” – underperforming the Dow.
Look at the long term – Buffett didn’t care about short-term results. He considered three years “an absolute minimum” for benchmarking. In frothy markets characterized by rampant speculation, Buffett asked his investors to judge his performance over five years.
Pick companies, not markets – Trying to predict the direction of the market or the economy is a fool’s errand. Buffett focused on finding undervalued companies with solid products and savvy managers. A bull market lifts all stocks, but Buffett argued his most important gift was not his ability to divine moves in the broad market; his underlying analysis of a specific company was the crucial factor in any investment decision. He relied on a fundamental analysis: were a firm’s assets worth more than its market value?
“I would consider a year in which we were down 15% and the Dow declined 25% to be much superior to a year when both the partnership and the Dow advanced 20%.” (Warren Buffett)
Buffett claimed no talent for predicting the direction of the overall market. He showed little patience for partners who second-guessed him after market corrections. Buffett once wrote that a number of his investors phoned to tell him stocks would continue a swoon that had begun a few months earlier. “If they knew in February that the Dow was going to 865 in May, why didn’t they let me in on it then?” If his partners couldn’t predict three months earlier where the Dow would be in the future, what made them think they suddenly achieved clairvoyance?
“The Dow as an investment competitor is no pushover, and the great bulk of investment funds in the country are going to have difficulty in bettering, or perhaps even matching, its performance.” (Warren Buffett)
“It is always startling to see how relatively small differences in rates add up to very significant sums over a period of years.” (Warren Buffett)
“If you’re uninterested, unable or unwilling to dedicate the time and effort to your investments, you should buy the index.”
“By understanding how and why an investment manager gets paid, you can compare their expected behavior with your own best interest.”
“There is no question that a long time period and a high rate of growth combine to produce nonsensical projections when allowed to go too far.”
Buffett discouraged frequent trading. He wanted to wait for opportunities he strongly believed would pay off. “I will only swing at pitches I really like,” he said in a 2007 speech. Buffett believed that most investors would profit if they could buy stocks only 10 times in their lives. This would force them to be certain before they pulled the trigger. This idea plays into Buffett’s penchant for buying into quality companies and holding shares for the long haul.
“Even modestly better results produce tremendous financial advantages when compounded over time.”
“Soggy Cigar Butts”
Buffett made his mark as a classic value investor. In the days before the Internet, Buffett pored over publications called Moody’s Manuals in search of undervalued, unloved companies. He was looking for obscure businesses with underlying assets that were worth more than the companies’ overall market values. Buffett referred to such organizations as soggy cigar butts – they were so nasty no one wanted to touch them. Strong-stomached bargain hunters could look past the generally disgusting conditions of the business and enjoy a “free puff.”
“We are looking for wide margins of profit – if it looks at all close, we pass.” (Warren Buffett)
“A public opinion poll is no substitute for thought.” (Warren Buffett)
“Deep Value” Investing