Dylan Lewis: Warren Buffett is arguably the most respected investor of all time, and for good reason.
In his 54-year tenure as CEO of Berkshire Hathaway, Buffett has delivered annualized
returns of over 20% for investors as of mid-2019, more than twice the pace of the S&P 500 over
the same period. And he's done it without applying any extraordinarily complex methods.
In fact, Warren Buffett's investment style is surprisingly simple.
In this FAQ video, we’re going to break down how the “Oracle of Omaha” invests
by looking at his current and past holdings and some of our all-time favorite Buffett quotes.
One of the most important things you need to know about Warren Buffett is that he invests
for the long term.
Perhaps my favorite Buffett quote of all time is, "You can't produce a baby in one month
by getting nine women pregnant." In other words, some things just take time.
The first thing you need to do if you want to invest like Warren Buffett is to stop chasing short-term gains.
Buffett doesn't judge is invest performance by looking at how well his stocks did over
the past week, month, or even year. Instead, he focuses on multi-year returns.
In fact, Buffett doesn't even buy stocks because he thinks their share prices are going to go up.
He focuses on buying good businesses that are well run.
This is certainly worked out in his favor, as Berkshire Hathaway's investment returns
speak for themselves.
As Buffett says, "If you aren't willing to own a stock for 10 years, don't even think
about owning it for 10 minutes."
While there are certainly exceptions, Buffett approaches all investments as if he's going
to hold them forever. There's another commonality with all his holdings.
If you look at Berkshire Hathaway's current stock portfolio, especially Berkshire's largest holdings,
you might notice that there isn't a ton of variety.
Specifically, among Berkshire's top 10 holdings, you'll find no fewer than seven banks,
as well as two large investments in food companies.
Apple is the only stock not in those two categories.
Many observers might say that Berkshire's portfolio lacks diversification, and that's true;
however, Buffett believes that's not necessarily a bad thing.
In fact, you could say that the lack of diversification is responsible for Buffett's best investment returns.
Simply put, Buffett feels it's better to have an undiversified portfolio made up of businesses
he understands than to have a diversified group of stocks he isn't well equipped to evaluate.
Buffett doesn't understand technology stocks as well, so you don't find very many in his portfolio.
He refers to this concept as "staying within a circle of competence."
As he says, "You only have to be able to evaluate companies within your circle of competence.
The size of that circle is not very important. Knowing its boundaries, however, is vital."
In other words, if you know banks well, as Buffett does, there's absolutely nothing wrong
with owning a lot of bank stocks.
Having a deep knowledge of the space gives Buffett a better sense of the actual value
of the businesses he's holding, and he's one of the most notoriously value-oriented investors
in the business.
As Buffett likes to say, "Price is what you pay, and value is what you get."
The basic concept of value investing is simple.
By investing in stocks that are trading for less than they're truly worth, you have an
inherent advantage as a long-term investor.
However, finding stocks that are trading at a discount is easier said than done.
A full-scale discussion of value investing is a little beyond the scope of the video,
but if you want to learn how to invest like Buffett, the best place to turn are the teachings
of Ben Graham, Buffett's mentor.
Buffett himself has referred to Graham's book The Intelligent Investor as the best book
on value investing ever written.
Now, you may be wondering, what characteristics does Buffett actually look for in businesses?
It's difficult to overstate how much value Buffett gives to outstanding management.
In his mind, a great shareholder-friendly management team can make an otherwise so-so
stock pretty attractive.
Conversely, and otherwise excellent business with a poor management team can be a losing investment.
Look for companies with a strong track record of raising dividends and whose management team
has their interests aligned with those shareholders.
For example, here at The Fool, we like to see incentive-based compensation tied to long-term
performance goals as opposed to a single quarter’s earnings.
Another concept that's important to Buffett's investing style is identifying durable competitive advantages,
often called moats.
For example, Apple's loyal customer base gives the company a big advantage going forward,
and is a big reason why the stock is Berkshire's largest holding.
Coca-Cola has a massive distribution network and one of the best-known brands in the world,
the combination of which gives it efficiency advantages and pricing power over some of its peers.
While Buffett does tend to have long-term relationships with the stocks he buys, he
also isn't totally wed to them.
Buffett once said, "All there is to investing is picking good stocks at good times and staying
with them as long as they remain good companies."
Pay particular attention to the latter part of that quote -- "as long as they remain good companies."
While Buffett is certainly a buy-and-hold investor, he sells stocks regularly and for
a variety of reasons.
If Buffett's original reasons for buying a stock no longer apply, he won't hesitate to move on.
As an example, it might surprise you to learn that Buffett built up a pretty large stake
in Freddie Mac in the 1990s.
By 1998, Berkshire owned nearly 9% of Freddie Mac, a stake worth $3.9 billion at its peak,
and a massive 1,200% return for Berkshire.
However, in 2000, Buffett abruptly sold nearly all of his position.
Why would he get rid of such a successful investment?
Well, Buffett noticed that the management team was becoming too focused on delivering
quarterly results, and they were starting to take on more and more risk to achieve those goals.
As we all saw during the financial crisis, these risks ended up being more than just
a small warning sign.
The lesson: don't be afraid to walk away from an investment if you don't like what's going on,
regardless of whether that stock is up or down.
Buffett said it best when he advised, "The most important thing to do if you find yourself
in a hole is to stop digging."
Some of the best Buffett quotes really good at the psychology of investing and maintaining
a level approach even when things go haywire.
Many investors fear market crashes, and it's not hard to see why.
Nobody enjoys watching the value of their investments plunge, and high volatility can
certainly be scary.
But Buffett has frequently advised investors that these are some of the best times to buy.
In his words, "Opportunities come infrequently.
When it rains gold, put out a bucket, not a thimble."
In fact, some of his most successful investments have come during and shortly after market panics.
For example, Buffett's $5 billion investments in Goldman Sachs and Bank of America in the
wake of the financial crisis have turned out to be massive winners.
Having said that, market panics are only good for long-term investors who are in a position
to take advantage.
This is one of the big reasons why Buffett likes to have a decent amount of cash on the
sidelines at all times, and why Berkshire avoids debt. As Buffett says, "Predicting rain doesn't count.
Building the ark does."
All of the Buffett wisdom that we're pulling into this video comes from decades of experience
and thousands of pages of reading on his part.
Buffett doesn't spend his workday sitting in meetings or watching the financial news,
or really even analyzing stocks that much.
Instead, the activity that takes up the most of his time is sitting and reading.
He regularly reads hundreds of pages a day and has said, "That's how knowledge works.
It builds up like compound interest."
He believes that the more knowledge an investor gains, the better position they'll be in to
make wise decisions and avoid making mistakes.
To recap, you can simplify Buffett's market-beating strategy down to a few core things:
• investing for the long term, • buying good businesses that are easy to understand,
• looking for strong management teams and
companies with durable competitive advantages, • viewing market dips as opportunities,
• and learning; always learning.
If you want to do some more learning on Buffett, this video is based on a fool.com article.
You can catch the link for that down in the video description.
If you want some good entry-level investing content, we've got a starter kit available at fool.com/start.
It walks you through all things investing, from saving money to buying your first stock,
and it has a five-stock sampler to get you started.
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If you have a favorite Buffett quote, drop it down in the comments section below.