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.

 

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