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If you want to mingle with the world's most successful crowd of investors, forget about visiting Bay Street or Wall Street. Instead, count on spending some time in Omaha. It's there that a mob of 15,000 enthusiasts congregate for the annual general meeting of Berkshire Hathaway Inc.
The thousands of apparently sane people who fly from all parts of the globe to spend a spring weekend in Nebraska do so for a compelling reason — they want to see Berkshire's chairman, Warren Buffett, up close and in the flesh. The 74-year-old multi-billionaire is the world's second-wealthiest person (behind only his good friend Bill Gates) and, by general acclamation, the greatest stock market investor in history.
The major vehicle for Buffett's genius is Berkshire, which he operates much like a closed-end mutual fund, investing in a grab-bag of private and public businesses. Through Berkshire, Buffett has been responsible for personally creating thousands of millionaires — the lucky person who bought $1,000 of Berkshire stock back in 1965, when Buffett took over the firm, would today be worth $4.7 million (U.S.). And despite his grey hair, Buffett shows no signs of losing his touch. Someone who bought Berkshire shares 10 years ago would have done nearly twice as well as someone who bought a broad stock market index. The person who invested five years ago would have beaten the market by 70%.
It's no wonder that investing groupies trek to Omaha every spring to gaze at Buffett's weathered face and listen to his folksy commentary on the stock market. But the good news is that if you can't make it to Nebraska for the annual general meeting, you can still learn how to invest like Buffett. The oracle of Omaha has never kept his philosophy a secret. He's written extensively on what he does and why he does it. Much of what he has to say flies in the face of Bay Street's conventional wisdom. But if you have half an hour, we can teach you the four tenets of Buffett's money-making philosophy. Ready? Here goes:
Keep it simple
Buffett thinks that constantly trading stocks is a good way to lose money, not make it. Equally useless are hours spent scanning what newspapers and websites are saying about hot companies or emerging trends. When asked if he spends a lot of time reading economic forecasts or market predictions, Buffett reportedly said: "Sure, I always enjoy a hilarious comedy."
Buffett believes that smart investors avoid the trends of the moment. Good investors also recognize the limits of their knowledge. "Never invest in a business you cannot understand," Buffett advises. He keeps his own investing within strict bounds. He has rarely owned a tech stock, for instance; he also avoids trendy startups as if they were a bad case of the flu. His biggest holdings are companies such as Coca-Cola, American Express, The Washington Post and H&R Block — solid, easy-to-understand businesses with long and profitable operating histories. Rather than jumping in and out of such stocks, Buffett has held onto many of his core holdings for decades.
Buffett's favorite companies enjoy what he calls a business franchise. A franchise in Buffett-speak is essentially a durable competitive advantage — an edge that is difficult for competitors to duplicate and that isn't going to go away any time soon. In the case of Coca-Cola, the franchise is a combination of size, marketing power and a brand name built up over decades. In the case of The Washington Post, the franchise is the power that stems from owning the dominant paper in the U.S. capital. If a company has a franchise, its stock price may go up or down at times, but it's a near certainty to perform well over the years. "Stop trying to predict the direction of the stock market, the economy, interest rates or elections," Buffet advises. Instead, he urges his followers to "buy companies with strong histories of profitability and with a dominant business franchise."
Demand honesty
Buffett wants any company he invests in to have managers who are honest — not just in a don't-get-caught-with-your-hands-in-the-cookie-jar kind of way, but in a deeper sense. Executives should strive to be candid with shareholders and they should always think of enriching shareholders first, themselves second.
The most reliable way to find such management is to look for firms with a high level of insider ownership by top executives. If managers are shareholders themselves, they're likely to take shareholders' interests to heart. Especially when managers own 10% or more of the stock, their interests are closely aligned with yours. Buffett has many investments in firms such as Nike, Moody's, Outback Steakhouse and Gap, which have insider holdings of 47%, 16%, 15%, and 24% respectively.
But what about massive firms that are too large for a few insiders to own more than 10% of the company? In these cases, Buffett searches for managers who act like owners. One indicator of such firms is that they keep executive pay at reasonable levels — and make no mistake, the differences among executives' pay can be breathtaking. Compare Magna International's Frank Stronach with Larry Prince of Genuine Parts. The two firms both make auto parts. But that's where the similarities end. Stronach pays himself $52 million versus Prince's $2.3 million. Where does Stronach's massive salary come from? If you're a Magna shareholder, it comes out of your pocket.
Huge paycheques are just one symptom of questionable management. Buffett also hates companies that play games with their earnings to satisfy Bay Street and Wall Street. A prime example is the way some companies buy back shares. Doing so can make sense if management believes the shares are undervalued and so represent a good use of company money. But some companies turn this policy on its head, selling shares to raise money when the share price is cheap, then turning around and buying back shares when the markets are hot and shares are trading at ultra-expensive levels of 30 or 40 times their earnings. This insane ritual burns through a company's cash — essentially it consists of buying high and selling low — and the only motivation for it is management's desire to fine-tune its earnings per share to satisfy the expectations of security analysts. In Buffett's view, such games are maddening. They destroy shareholders' wealth.
Think like an owner
Most money managers obsess over a company's most recent earnings and day-to-day shifts in its stock price. They're quick to dump a company that falls short of their expectations over the past quarter. But Buffett thinks such fast-twitch buying and selling is silly. He believes successful investors think like business owners rather than traders. To Buffett's way of thinking, you shouldn't dream of owning a stock for 10 minutes that you're not prepared to hold for 10 years. Day-to-day movements in the stock price are irrelevant; so are ups and downs in a company's quarterly earnings. "An investor should act as though he had a lifetime decision card with just 20 punches on it," Buffett says. That means buying a few good companies and sticking with them for the long haul.
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