Increasing your capital seven million times over: Warren Buffet’s investment philosophy
Warren Buffett….anyone who follows the stock market knows his name. Born in Nebraska, USA in 1930, he is known as “The Sage of Omaha” or the “God of stock investing”. He was ranked the third richest person in the world in Forbes’ Billionaire’s list in 2015. At Berkshire Hathaway’s AGM, the investment holding company of which he is both Chairman and CEO, held in May last year, a crowd of 4,000 people thronged to listen to what the “Sage” had to say about investing and company management.
Buffett’s fortune was estimated at US$72.7 billion in 2015, consisting mainly of his shares in Berkshire Hathaway (of which he is the largest shareholder). When we consider that he started out with US$10,000 of capital, built up as a student, and that he has increased it by 7.27 million times over, that is a stunning achievement. The title of Buffett’s biography, “The Snowball”, seems strange at first, but is actually highly appropriate. It speaks to the way in which his fortune has expanded like a rolling snowball.
Buffett’s investment philosophy is based on a combination of value investing and growth stock investment. He picks stocks where, having built up a detailed view of the company, he believes the shares are underpriced relative to the business’ intrinsic value, on a medium to long term view of growth prospects.
Originally, Berkshire Hathaway was a textile company: it was a classic value investment. Buffett bought up shares in the company and assumed control of the business in the mid-1960s at a time when it appeared extremely undervalued. This was the beginning of the Berkshire Hathaway investment portfolio.
In terms of his principles, he avoids investing in venture businesses, or start-ups, where results are highly susceptible to unknown risk factors. His mantra is you should never invest in businesses you do not understand. He feels most comfortable buying long-term, mature and stable businesses, particularly those which sell consumer products and services.
He favors monopolies or market leaders, or businesses with strong brands in his portfolio: IBM, Coca Cola, P&G, American Express, Walmart, for example. These are familiar businesses: you know what they do, and how strong their market positions are, as soon as you hear their name.
Berkshire Hathaway’s largest shareholding is Wells Fargo. It is not such a well-known brand name outside America, but in the US it is regarded as a blue-chip bank, especially where personal loans are concerned.
His aim is to generate income over the medium to long term as the business grows, and not to be distracted by short-term share price movements. As and when his investment view changes, he sells, and locks in his profit.
He has faced some criticism over his holding in IBM, built up in recent years after the stock had already outperformed, seemingly at a price more appropriate for a growth stock rather than a value investment. Last year, Berkshire Hathaway announced that it had lost $2 billion on its holding in IBM so far. In a regulatory filing, however, Berkshire re-iterated its commitment to IBM, saying the downturn in the share price is "temporary." Investors must assume that his adage, “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price” is particularly applicable in this instance.
Buffett made his first investment in the stock market when he was only 11 years old. He bought three shares of Cities Service, an oil service business, for $38.30. The stock fell below his in-price, but recovered in due course. Although he made a small profit, selling out at $40.00, it actually rose to $202 not long afterwards. For him, that was a valuable lesson in the risks of short-term stock trading, as opposed to taking a longer term view of a business
However, Buffett’s investment style is not just about a few simple mathematical calculations. For example, he looks at return on equity; whether the business can sustain high profit margins (% of profit/revenue); whether it can generate sustainable growth on a consistent basis; and whether debt levels in the business are appropriate relative to profit. Other than mathematical ratios, his key points of focus are: whether the business is simple and easy to understand; how he rates the ability of the company’s management; the business’ future growth prospects and opportunities.
But even the so-called “Sage” or “God” does not get everything right. For example, he has admitted that his investment in Tesco, the UK supermarket retailer, originally acquired in 2006, was a “huge mistake”, with the stock falling heavily in 2014 as a result of accounting irregularities.
Having said that, any ordinary investor trying to emulate him would be satisfied with just a tiny fraction of the profit he has made over the years.