Warren Buffet: How to adopt the philosophy of a legendary investor

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Warren Buffet: How to adopt the philosophy of a legendary investor

Legendary investor Warren Buffett is probably the most famous living investor. We explore the investing methods, philosophy and lifestyle that brought him his success.

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Building on our first article on 'the man who broke the Bank of England' George Soros in this series on the masters of trading and investing, we move onto billionaire investor Warren Buffett.

$1000 invested with Warren Buffett in 1969 is worth $4,640,976 today…

One of the things people admire most about Warren Buffett is his consistency. The investing company that Buffett founded – Berkshire Hathaway – has been earning money for investors for over 50 years. Not many investors have right psychology and endurance to invest and survive at the highest level for that long.

"I made my first investment at age eleven. I was wasting my life until then." Warren Buffet

Contents: Warren Buffett Investing

• Who is Warren Buffett?


• Buffett's background: The making of the legend


• Warren Buffett's best investments


• What is the Warren Buffett investing strategy?


• Buffett quotes and his investing philosophy

Who is Warren Buffett?

Warren Edward Buffet is one of the most successful value investors the world has ever seen.

He became iconic in the investing world for picking massive winners. Berkshire Hathaway has delivered a compounded annual gain in per share market value of 20% over the past 55 years, a level of return on investment (ROI) few can match.

He developed a keen business ability from a young age before forming Buffet Partnership Ltd in 1956. By 1965 he was CEO of Berkshire Hathaway, a company which owns over 60 companies including Duracell, the battery maker and Dairy Queen, the fast-food restaurant. Berkshire also has stakes in Coca-Cola and America Express.

His renowned investment strategies have not only earned him the nickname the "Oracle of Obama" but also earned him vast fortunes. Warren Buffet is one of the richest men on the planet with a net worth of $102 billion at the time of writing. He is number 10 on the Bloomberg Billionaires Index.

Buffett is known for his down to earth attitude which is reflected elsewhere in his life. He doesn't live in the fast lane, preferring to live in a modest house, drive the same car for 10 years and drink Coke whilst not spending money frivolously. He comes across a regular Joe, but one that appreciates that price and value are not always the same thing

The psychology Buffett adopted after his first trade

Warren Edward Buffet was born Omaha, Nebraska in 1930 to his mother Leia Stahl Buffet and his father Howard. His father worked as a stockbroker and as a U.S Congressman.

Warren Buffet found a flair for finance and business matters from an early age. Considered a mathematical prodigy, at 11 years old he made his first investment, learning two lessons that stayed with him throughout his career.

Warren Buffet bought three shares of 'Cities Service Preferred' for a price of $38 per share. Soon after, the stock declined 30% to $27. Yet Buffet held on believing in his position, until it climbed back to $40. At this level he sold his shares. However, he regretted the move as Cities Services Preferred share price surged to almost $200.

With this first trade, Buffet learned two simple but ultra-important lessons in trading psychology.

1. The value of patience. Holding his nerve and waiting for the investment he believed in had proven even more important than picking the right investment.


2. He also learned that short term changes in a stocks' price may not be tied to its value, but such moves can still cause emotional discomfort.

These lessons were the first of many lessons in investing that Warren Buffet has learned from and which have helped him to develop his successful investing strategies.

Warren Buffett's best investments

Warren Buffet has made many extremely successful investments. One of those is Apple. The Apple share price has surged over 400% since Buffet started to invest in the company in late 2016. The tech company now represents the largest holding of Berkshire Hathaway, accounting for around 40% of its entire portfolio. Buffet has reportedly made around $100 billion on his Apple investment including dividend payments of $3 billion.

 

Bank of America has been another standout performer for Warren Buffet. This is the second largest holding at Berkshire Hathaway and represents around 14.5% of its portfolio. Buffet started buying these shares in 2011 at a reduced price with a $5 billion initial investment, building his stake to total $39 billion in shares. Whilst Warren Buffet sold stakes in top banks in 2020, he continued adding to his Bank of America Holding. The stock has brought investors returns exceeding 74% over the past 12 months alone.

What is the Warren Buffett investing strategy?

Warren Buffet is infamous for his value-based investing model.

Value investing means prioritising a long-term outlook over short-term profit. Warren Buffet is a firm believer that you should only buy stocks in companies which have strong fundamentals, robust earning power and the potential for further growth. These appear to be fairly straight forward and logical concepts; he is of course known as being a straightforward and logical person. However actually detecting these values in a company is not necessarily so simple.

Perhaps even more importantly, value investing – an inherently contrarian style that means buying when others are selling and vice versa – means having the patience and courage to see the investments play out. Again, investing and trading psychology is paramount to become the best like Buffett.

Warren Buffet developed a list of principles to help implement his investment philosophy to maximum effect. The four principles are:

1. Business


2. Management


3. Financial measures


4. Value

Within each of these principles Buffet adheres to certain rules.

For example, under Business, Warren Buffet will only invest in businesses he can easily analyse. If its easy to analyse its easier to project performance. Trying to successfully project the performance of a company you don't understand is impossible at best. Here Buffett distinguishes himself from many investors – he does not invest using hope- this is an emotion that should be avoided.

Under Management, Warren Buffet studies those in charge to determine if the favor reinvesting profits back into the company or if they prefer to distribute funds back to share holders through dividends. Buffet favours the later. He also values transparency, accepting that everyone makes mistakes, but only those that disclose these errors are should be invested in.

Within the financial principles Warren Buffet favours low levered companies which boast high profit margins. He uses a metric called Economic Value Added, this estimates a company's profits once the stakeholders' stake is removed from the equation. To put simply EVA is net profits minus expenditure raising the capital. Separately Warren Buffet also looks at owners' earnings, which he considers useful in determining a company's ability to generate cash for shareholders.

Finally Warren Buffet looks to determine a company's intrinsic value. He does this by projecting future earnings and then discounting them back to present day levels. Buffet, learning the lesson from his first investment usually ignores short term market movements instead focussing on long term returns. There are of course exceptions here, if a fundamentally strong company suddenly drops sharply, Buffet has been known to pick up extra shares at a discounted price.

Buffett quotes and his investing philosophy

Warren Buffet's investing philosophy is value-based. To emphasise -that is the opposite to being  hope-based or following the crowd-based.

Buffett, even today at over 90-years old, is looking for company's whose share prices are unjustifiably low given their intrinsic worth. He is not concerned with how the market views the company but instead on how well that company can make money as a business. He drills down into the company's fundamentals and adopts a patient approach. Buffet once wrote in a letter to shareholders that:

 "“[Our] favourite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint."

-- Letter to shareholders for the year 1988

Discipline, patience, doing something different to everybody else and having the conviction to follow through on his ideas have been corner stones to Buffet's success (Remind you of anyone? #Soros). Patience is a golden rule in investing, not only waiting for the right opportunity but also staying with what works well. Courage and a belief in his plan have been fundamental to becoming the legendary investor he is today.

Indeed, it's worth noting that Buffets' financial success can be tied to the base that he started building in his youth. Buffet is the proof that investing in your financial future from an early age is huge beneficial. Holding onto stocks long term, puts you in the position of benefitting from compounding gains.

Buffett-style investing isn't about the highest possible short-term returns but rather recognising the investments that can earn consistently over time and having the psychology to stick with it.

"Price is what you pay. Value is what you get."

The post Warren Buffet: How to adopt the philosophy of a legendary investor appeared first on Key To Markets Blog.

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