Investing Lessons from the Masters : Warren Buffett

Warren Buffett is probably the pin up boy for value investing. And he’s become fabulously wealthy in the process . But what can you learn from Buffett’s style of investing? 

 

Who is Buffett?

Aside from being one of the top 3 or 4 wealthiest people in the world, Buffett is one of the founders of Berkshire Hathaway a listed investment company on the NYSE. He is famous for turning an initial stake of $105,000 into a $30B + fortune.

How does he invest?

Buffett is a classic contrarian investor focussed on extracting value from companies with strong competitive advantages that are out of favor with investors. He focusses on the best businesses, whether or not they pay dividends, that he plans to hold forever. In fact, Buffett is famous is famous for saying that in his view, the best time to sell is never.

Buffett’s approach to investing is focussed on first identifying a durable competitive advantage typically created by the production of a unique product or service with high barriers to entry. This is best illustrated in the case of an investment like the Coca Cola (KO). Coca Cola  has been selling a variety of soft drink beverages for years. It has strongly protected, unique Intellectual Property. Coca Cola has produced sustained consistent earnings growth over many years.

Buffett loves to buy on bad news. He is famous for moving in on companies that have strong competitive advantages that went through some tough times that made them out of favor with the general markets. Businesses fall out of favor with the stock market for a variety of reasons including stock market corrections, recession, individual business problems or unforseen black swan events such as war, natural disasters, acts of terrorism etc.

Classic Warren Buffett Plays

Geico. In an effort to boost profitability, Geico decided to ensure any and all comers at one point, including those that were more accident prone. As a result of a relaxation in insurance underwriting provisions, Geico had started to experience an increase in insurance losses which placed in a tough spot at one point in the mid 1970′s. Sensing an opportunity, Buffett made an investment in the business which returned 40x before he subsequently bought out the company in full in the 1990′s

American Express – American Express was involved in an insurance scandal, known as the “salad oil scandal” in the 1960′s where they “verified” the existence of salad oil in a oil tanker. Unfortunately for American Express, this salad oil did not exist in fact. American Express was on the hook for this loss to the tine of $60M, which sent investors running away from the stock. Of course, the existence of the loss had nothing to do with the underlying strengths of the company and so Buffet made his move with an investment that has substantially appreciated over time.

Goldman Sachs – During the crisis of 2008-2009, investors were fleeing the banks in the fear that every one of them was carrying some sort of toxic asset on their books. Goldman Sachs, was similarly affected by a lack of investor confidence in the fear that it may have been holding some toxic credit derivative assets in its portfolio. As investors sold down the stock, Buffett again moved in with a $5B investment of preferred stock and warrants that allowed him to purchase stock in the company should the price rise above a certain level. The investment paid Buffett an annual dividend of $500M a year. It was so successful for Buffett that Goldman Sachs actually repurchased the preferred shares in 2011.

Buffett had similar plays in effect with Bank of America and General Electric at various times during the financial crisis

What does he hold now?

Buffet still has holdings in a variety of companies with strong competitive advantages. His holdings include companies such as Coca Cola, American Express, Wells Fargo, IBM, GE, Walmart, Visa, Bank of America, Johnson & Johnson and Moody’s.

What can you learn from Buffett?

Invest in strong businesses – Buffett gravitates toward strong business with sustainable competitive advantages. He doesn’t look to buy junk, even if its on sale.

Don’t fear negative circumstances – Buffet welcomes bad news. whether its general bad news in the economy or company specific bad news. Rather than running away from it, some of Buffett’s best performing investments came during bad times in the economy or for a stock.

You make money from bear markets, you realize the returns in bull markets – Many of the Buffett plays discussed above were made during bear markets, either market specific or stock specific. While Buffett’s play was made during bear markets, he realized the value of this play several years later when opinion turned in favor of a specific stock or in the economy (and when companies like GE, Goldman Sachs tried to repurchase his loans!).

There are many books that have been written on Buffett and his investment methodology. One of my favorites is The New Buffetology by Mary Buffett if you are interested in reading more.

 

Comments

  1. I think there are a lot of good examples out there for us to follow. I think the important thing is to save and invest. If you do that you should always be ahead of the game. We are big index investors. We like the diversity and simplicity.

    • Integrator says:

      Well said Miss T!. Without the basics of savings in place, none of the other things will follow. Buffet himself is a big advocate of having individual investors invest in index funds. He has a fairly large wager ongoing with some hedge fund types that his index fund pick will beat out their hedge funds.

  2. I see bear markets as great buying opportunities. And since almost all the stocks I hold paid out and increased dividends throughout the great recession, I’m not that worried about my income dropping like a rock in the next recession. If I was solely focused on capital gains, I would be terrified.

    • Integrator says:

      The interesting thing about the last recession was that most of the non financials continued to maintain, if not increase their dividends. Coca Cola, Johnson & Johnson, Procter & Gamble, Clorox all increased their dividends, even while the likes of Bank of America and Citigroup slashed theirs. I read that 71% of dividend champions all maintained or increased their dividend during the 08-09 recession. Most of those that didn’t were financial companies.

  3. Good topic! Buffett is someone we can all learn a lot from. His purchase of Geico and the amount of money he made from that is still legendary to me. Whenever I think about what stocks to invest in, I do always come back to his principle of investing in a SOLID company with a lot of potential for the future.

  4. I love Buffet’s style, no crazy strategy or technical analysis. He simply studies a business and waits until it’s at a great value then buys it and HOLDS.

    • Integrator says:

      The great thing about following his approach is that you don’t need to be an active market watcher or trader. Monitoring business performance (vs stock performance) is enough to be successful with his approach.

  5. I believe the wealth strategy of Warren Buffett. He is a great and legendary stock investor, his wealth accumulation secrets includes investing in profitable companies with consistent earnings. He is fond also of buying other businesses throughout his life like Nebraska Furniture Mart, Scott & Fetzer, Coca-Cola, Johnson & Johnson, Procter & Gamble

    • Integrator says:

      Thanks for stopping by MWD. Consistent earnings growth is definitely one of the keys to Buffett’s success. That consistent earnings growth comes from businesses with large moats and sustainable competitive advantages.

  6. “You make money from bear markets, you realize the returns in bull markets”

    I love that because it’s so true. I loved in 2011 and 2012 when the markets were volatile because it gave us chances to get back in after a quick move up. I’m expecting around mid-year for volatility and hopefully a corresponding market drop to show up. I love the “Sell in May and go away” because it lets us long term investors pick up some great companies.

    • Integrator says:

      Absolutely JC. I’m looking forward to when the markets next panic about Europe. I’m expecting another bout of nerves in the summer that should provide some interesting investing opportunities.

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