Business Leaders: Warren Buffett
Growing Business analyses the business theory behind “one of the world’s greatest investors” – uncovering the secrets behind his estimated $62.5bn worth
Name: Warren Buffett
Expertise: Legendary investor, currently worth $50bn, whose company has performed twice as well as the S&P 500 since 1965
Known for: A highly consistent and long-term approach to financial investments, which is known to many as the ‘value investing’ philosophy
Best-known titles: The Snowball: Warren Buffett and the Business of Life, Alice Schroeder (2009); The Warren Buffett Way, Miller, Hagstrom & Fisher (2005); The Essays of Warren Buffett: Lessons for Corporate America, L Cunningham (1998)
Who is Warren Buffett?
With nicknames such as ‘the sage’ and ‘the oracle’, Warren Buffett is renowned as one of the world’s greatest investors, and millions of aspiring stock pickers know his proverbs off by heart. His company, Berkshire Hathaway, boasts a stock portfolio worth more than $62.5bn, encompassing multinationals such as Coca-Cola, MasterCard and Kraft Foods. Buffett himself is one of the richest men in the world, named the world’s wealthiest person in 2008 and most influential in 2012.
What is Buffett known for?
Buffett is renowned for ‘value investing’, an often unfashionable approach to investing that had been initially developed by Benjamin Graham, author of The Intelligent Investor. Buffett invests primarily through the publicly quoted Berkshire Hathaway. Berkshire Hathaway was already an established, though small and little known, company when Buffett assumed control in 1965 and it has never given the world a brand-new product or service during his 46 years in charge.
Instead, Buffett has made his fortune through an innate genius for investment; for spotting a company which is undervalued by the stock market and which pays good, regular dividends; and holding each investment for many years, ignoring modern trends to buy and sell frequently. Since 1965, Berkshire has performed twice as well as the S&P 500; if you’d invested $10,000 in Berkshire back in the mid-1960s, your stake would be worth $49m today.
While he has never written complete books, he writes extensive reports about investing every year in Berkshire Hathaway’s annual report, and these have become highly prized, influential documents – by far the best-read annual reports of any quoted company in the world.
The roots of Buffett’s incredible success can be traced back to his studies at Columbia University where he was tutored by legendary investor Graham. When investing, Graham focused on the ‘intrinsic value’ of a business rather than short-term vacillation in its share price, believing that the stock market regularly overvalues companies and undervalues companies as emotional traders follow each other into or out of a particular share. By understanding what a company is really worth, it is then possible to buy its shares when the share price on the stock market is less than their true value, and sell them when it is above the true value. Graham liked investors to regard themselves as part-owners, rather than simple owners of a piece of paper (the share certificate) whose price fluctuated almost regardless of the intrinsic value of the company.
His lessons remain integral to Buffett’s approach to this day; in fact Buffett has described Graham as the second most influential person in his life, after his father. One of the keys to Buffett’s investing strategy is what he calls ‘the float’. He likes buying companies which generate substantial cash flows, in particular insurance companies, which charge premiums often years before they need to pay out on any claims. This leads to large sums of cash which insurance companies invest – and which Buffett has been able to put to extremely good use. Insurance companies have long formed the backbone of Buffett’s investment holdings. Buffett’s philosophy can be condensed into five key points, each illustrated by one of his famous quotes.
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Rule No 1: Never lose money. Rule No 2: Never forget rule No 1
Buffett looks to minimize risk wherever possible, which he does by extensively researching potential companies to invest in, and by only buying when he believes the share price he buys at is less than the underlying value of those shares, based on reliable cash flow generation and the value of assets the company owns.
Buffett is profoundly cynical of high-growth shares that are priced on the stock market at very high multiples of sales or profits; especially when these companies have not ever made a profit. During the dotcom boom of 1999/2000, Buffett refused to buy into what he called the ‘irrational exuberance’ of online start-ups – preferring instead to stick to simple industries, such as energy and insurance. Buffett’s investments thrived as the dotcom bubble burst, leaving more people impressed by his approach than ever. He remains cynical of tech companies to this day; another of his favorite maxims is ‘never invest in something you don’t understand’.
You can’t buy into what is popular and do well
Buffett may be happy to back established names, but he generally finds them most attractive when they are forgotten or unloved. He has invested in both American Express and Geico when they were on the verge of insolvency, and bought substantial stakes in Goldman Sachs and GE in 2008 when their share prices were at almost historic lows. Buffett is a born opportunist, who is at his most effective during lean times. He urges investors to ‘be fearful when others are greedy, and be greedy when others are fearful’.
Price is what you pay. Value is what you get
When Buffett is weighing up an investment, he looks beyond its immediate share price and explores the business fundamentals, and potential, of the company. He will closely examine a company’s corporate structure, and its working practices, in an attempt to ascertain whether it has the foundations for sustainable success.
In terms of numbers, a business has to have a consistent trading history, low levels of debt, and a proven track record with reference to metrics such as return on equity, return on invested capital and profit margin. Buffett also looks for companies with ‘the moat’ – a barrier to other companies, often provided by a distinctive brand and a loyal customer base. Buffett is happy to pay a reasonable price for a company with pedigree; one of his many maxims is that ‘it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’.
Our favorite holding period is forever
When Buffett does invest, he commits for the long term – in fact patience is arguably his definitive attribute as an investor. This attitude can be traced back to his first serious investment, when, after selling shares at $40, he had to watch helpless as they reached $200 in value – and to his apprenticeship under Benjamin Graham, who preached that investors should not be too concerned with short-term fluctuations in stock prices. Buffett is happy to wait years, even decades before selling stocks, rather than searching for a quick sale.
If a business does well, the stock eventually follows
Buffett looks upon each investment as a partnership; when an investor buys shares in a company, they should feel as though they are buying the company itself and in his ninth decade, he remains as committed and as hands-on as ever. He proudly admits to reading hundreds upon hundreds of company reports every year, and immerses himself in all aspects of Berkshire’s operation – often answering phone calls to his company personally. He demands daily reports on each of the many companies within Berkshire’s aegis, and channels excess cash around his empire. Essentially, Berkshire operates as a private equity firm, not as a fund manager.
How real companies use Buffett’s concepts
It seems that every statement Buffett makes causes a ripple effect in the investment community; when, for example, he told reporters he paid close attention to the ‘freight train index’ which monitors the movement of raw materials around America, the index shot to the top of Google Trends almost instantly. Buffett has many prominent disciples in the investment community; a good example is Norman Rentrop, of global investment firm Rentrop Investment Office, who has based his success on Buffett’s principles, particularly investing in undervalued public companies and pursuing private equity with a very long-term outlook.
It’s impossible to quantify the impact of Buffett’s concepts – no-one can know for sure how many companies and investors have taken inspiration from his words and career. However, it’s safe to say that many millions of people have been exposed to Buffett’s ideas. Buffett regularly writes opinion pieces for respected publications such as the New York Times, and books such as The Snowball have propagated his approach among a huge audience.
Buffett is also regarded as one of the investment world’s most inspirational speakers, thanks to his earthy, homespun and humorous aphorisms. His speeches at Berkshire’s annual shareholders’ meeting attract more than 20,000 visitors every year – with some dubbing the meeting ‘the Woodstock of Capitalism’.
Buffett’s long-term, risk-averse approach seems more valid than ever in the current economic environment; his oft-cited criticism of derivatives back in the early years of the new millennium has only served to reinforce his reputation, as the concept of derivatives has pushed the financial world towards recession. Furthermore, Buffett has continued to make money during the downturn, burnishing his status as an investment genius.
There will continue to be outspoken investors who believe that Buffett’s steady, straightforward approach is outdated. As the technology continues to develop, so more and more traditional businesses will be challenged. But Buffett began his investing days by buying into established companies often operating in declining markets, and did very well from it. His approach, carried out properly, would seem to remain as valid today as it was when he started.
Business Gurus, edited by Ian Wallis and published by Crimson Publishing, is available to order now.