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Smart Investor: Warren Buffett – lessons from the ultimate value investor

Smart Investor questions how Warren Buffett has managed returns of 20% a year since 1965. The answer, it seems, is simplicity, patience and discipline.

Smart Investor: Warren Buffett – lessons from the ultimate value investor

Smart Investor questions how Warren Buffett has managed returns of 20% a year since 1965.

If I were to tell you that the most successful investor in the world makes fun of technical analysis, laughs at the thought of beta and thinks the efficient market hypothesis is a joke, would you believe me?

Rewind to 1965. Berkshire Hathaway was a loss-making textile company on the road to nowhere. Today its book value is around $95,000 per share (up from $19 per share in 1965) and it is all down to one man: Warren Edward Buffett.

Indeed there are very few people who make a mark on the world as Buffett has done. When he began buying shares in Berkshire Hathaway in 1965 he paid around $15 per share on average and, by his own admission, made countless mistakes in the beginning. He tried to grow the textile business and even ended up buying part of another textile company – both of which struggled to make much in the way of profit.

However he quickly came to his senses and set about turning Berkshire into a holding company which purchased shares in other businesses such as Coca Cola, American Express and, most recently, Burlington Northern Santa Fe.

In doing so he has become one of the richest men in the world. Yet he preaches simplicity, patience and discipline as opposed to spouting technical jargon. Surely if ever there was a man or a method for private investors around the world to follow, it is Warren Buffett. Indeed what has made him stand head and shoulders above all others year after year for the last 46 years?

Wisdom of years?

The first thing to mention when it comes to Warren Buffett is his age. He is 80 years old and has dedicated the last 60 or so years to investing. This leads many critics to say that he has had a formidable amount of time in which to learn and develop his ability to analyse companies and make investments. However Buffett was exceptionally successful even in his 20s so whilst time may have helped him to improve, he was extremely competent to begin with.

Buffett is known to be prepared to wait forever for the right price. He may want to buy 50 stocks on the S&P 500 but is prepared to buy none if they fail to fall to a price at which he feels they are fairly valued. How many private investors or indeed professional investors are prepared to do the same? Sure we all know the quote 'Buy when blood is running in the streets' but can you honestly say you would be happy to do nothing year after year whilst the market is rising and you are ‘missing out’ when everybody else is making a quick buck? Buffett will.

Of many Buffetts

Indeed the patience and discipline Buffett shows are not necessarily down to intelligence or education; they are in fact a part of his character. In the most recent letter to shareholders he recounts a tale of his grandfather Ernest Buffett who sent $1000 to his younger brother (Warren Buffett’s uncle) to keep as cash ‘just in case’. Buffett adopts a similar principle but substitutes the $1,000 for $10 billion. From the letter it is clear that Buffett had sound and logical financial principles taught to him from a relatively young age not by billionaires or millionaires but by hard working Buffetts who knew the value of thrift, liquidity and value.

Buffett is known to be able to value a company in seconds. Not minutes, hours or days as it takes many investors, but seconds. This does not mean he will invest in a company after analysing it for a few seconds but it does show that his first filter is price. If a company is reasonably priced he will then go on to assess the viability and future prospects of that company. Furthermore if he can estimate a company’s value in seconds it shows that his method of valuing companies is quite straightforward and simple. Indeed it may be worth bearing this in mind before you begin applying detailed ratio analysis to a range of stocks.

Secret recipe

On the topic of valuation, many fans of Buffett have attempted to second guess his valuation method. To my mind Buffett has only ever hinted at what it is, but has never explicitly explained his methods. I could speculate on it being discounted cash flow or price to book multiplied by price to earnings or some other method but it would probably be a waste of time. As mentioned, whatever it is, his method is clearly simple and fast – its success lies in applying it to a wide range of companies so as to find the handful which are reasonably priced. In any case Buffett says that no two people’s valuations will ever be identical, so the fact you do not know his method should not be a major concern.

Economic moats (the competitive advantage that one company has over others – a term coined by Buffett), competent management and product simplicity are characteristics Buffett looks for in acquisitions. Don’t just take my word for it though; take a look at the list of current Berkshire Hathaway holdings and you will see that practically all of them tick these three boxes. There are no technology companies for example but stocks such as Coca Cola, Wal-Mart, Kraft, Wells Fargo and Tesco are held because they provide goods/services which are likely to always be in demand. In addition they are simple to understand and enjoy high barriers to entry and customer loyalty (albeit to differing degrees).

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10 comments so far. Why not have your say?


Mar 07, 2011 at 07:40

No tech? BYD is a tech company. Nalco was kind of a tech as well. GE is ultimately a technology company.

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Twister Spitzer

Mar 07, 2011 at 08:16

"his first filter is price" Wrong! Buffett is on record as saying that he values a company first, and then looks at price. He does it that way so that the price doesn't influence his estimation of the company's worth.

"Buffett is known to be prepared to wait forever for the right price." Perhaps some context is needed, though. He has to play it that way now that BRK is so big. He said, in the early 90's, that if he "only" had a million dollars he would be fully invested, as he reckoned there would be enough small-scale opportunities to be viable for the amount available.

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Mar 07, 2011 at 08:34

I attribute part of Warren Buffett's success to the insurance companies he bought. When he was running the textile business he began to understand, just how expensive it is to finance a venture, if you adopt traditional methods. He realised that the insurance format gives its manager a "free" pool of money to invest at will until someone makes a claim.

If the risk model has been designed correctly that pool of free money will never run dry. His skill has been to invest that capital in sustainable high margin businesses, which has produced a multiplier effect.

He has been able to further develop the insurance element by using the rest of his portfolio as colateral security. His biggest wealth generator is now re-insurance. When I say re-insurance, I mean, although the risk is relatively low, very few of his competitors could contemplate paying out such large claims.

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jonathan farrington

Mar 08, 2011 at 21:56

To add to your excellent article, Buffett is also on record as stating that he avoids any business whose future he cannot predict and cites examples including autos 1910, aircraft 1930, televisions 1950. That's why he avoids tech companies.

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Mar 13, 2011 at 11:51

Whilst interesting to read I'm unsure whether ordinary private investors can learn much additional expertise from Warren Buffet because the situations are so different.

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Mar 13, 2011 at 12:28

At the risk of being shot down (which doesn't bother me), I would have though that 20% per year is not all that difficult if you can devote all your time to it. The real gains come in the compounding effect of re-investing the 20% gain each year since 1965. Get out your pocket calculator and see what I mean.

I can't quite see the point of an article praising Warren Buffett if we can only speculate on how he values the companies whose shares he buys.

People also tend to forget some of Warren Buffett's more controversial sayings - such as "Diversification is only necessary for beginners"!

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Sean Cawley

Mar 13, 2011 at 14:55

"So he is prudent, disciplined, patient and logical" Sums up the article for me. I am never quite sure what 'prudent' means but I can say with certainty my biggest mistakes have been when I was not disciplined or not patient or not logical.

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Mar 14, 2011 at 09:18

So he's 80 years old and worth $50 billion - what for - he can never spend it - what a sad life - devoted to making money he can't spend - what a pointless existence!

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Mar 14, 2011 at 09:51

Diabla.........I'm not sure many would agree with your views that someone who has never wanted for anything, always spent their days doing what they love doing and leaves $50 odd billion to charity has led a wasted life. If you can compete with that then your real name must be Gates!

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Mar 14, 2011 at 13:05

"They get it in their pap"

Because of parental tuition and the domestic environment into which they were born many successful businessmen get a head start. The right education, and the opportunity to mix with influencial people carries a lot of weight.

I suspect that many individuals such as myself, received educational guidance which set them on the road to nowhere. Only after learning many lessons in the school of hard knocks do we fully realise what we should have been doing all these years.

I was given the advice "If in doubt, refer to a higher reference value" so following logically, I have read books, by Jim Slater, George Soros, Peter Lynch, and Antony Bolton, among others. I have learned something from all of them, but I don't try to emulate their examples. Their stratagems are simply not applicable to my situation. All I know is that I am making fewer mistakes than I used to, so maybe the combination of small details are having a cumulative effect.

Diabla: I'm not sure that your point is valid, because I think we need people like Warren Buffett to show the rest of us what is viable and sustainable in an economically progressive world. However I accept that it takes all sorts and alternative lifestyles are worthy of research and investigation; therefore you might like to consider what Franklin Sanders has to say. He writes an erudite and often humorous running commentary on the state of the markets on According to him; there is no future in stocks, the US govt. is misguided, and even the US supreme court is sometimes wrong. However he admits to being just a "natural born durn fool from Tennessee". Despite his unconventional approach to economics he seems to be able to sustain a pretty good lifestyle. If you google Top of the World Farm, Dogwood Mudhole, Tennessee. you will see what I mean.

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