Warren Buffett is unquestionably the greatest investor who has ever lived. He possesses an uncanny ability to choose incredible investments that explode in value over time. This ability has earned him a place as the second wealthiest man alive today.
Despite his vast wealth, Warren continues display a public persona of humility and common folk wisdom. This attitude has provided him the respect of working people as well as the ultra rich; a very rare combination in this day and age. He does not believe in personal or family dynasties and has pledged to give away 99% of his wealth in his will.
How Did Buffett Get So Wealthy?
Buffett learned his investing skills from Benjamin Graham, David Dodd and Phil Fisher. He claims to be 85% Graham and 15% Fisher is his stock picking philosophy.
His basic investing concepts are the following:
1. Look at stocks as individual businesses
2. Use the market’s fluctuations to your advantage
3. Be certain that there is a margin of safety built into all your investments.
This stock picking method is widely known as value investing.
Value investing adheres to the idea of buying stocks that are under priced per fundamental analysis. In other words, stocks are bought at a discount to their intrinsic proper market price. This discount is what Buffett considered the margin of safety.
The best part about Buffett is his willingness to share his tactics and stock picking methods with everyone. He really lays everything on the line so savvy investors are able to follow in his footsteps. Not only does Buffett hold no secrets, he publishes a yearly investor letter that explains the minutia of his thought process.
His most recent letter carefully laid out the six things he insists upon prior to acquiring another company. This criterion is easily applicable to every stock investor when choosing companies for investment.
Here are Warren Buffett’s Six Acquisition Rules
1. Size
Buffett does not mess with small companies. The company need to produce a minimum of $75 million in pre-tax earnings.
2. Consistency
He has no interest in speculation when it comes to earnings. In other words, future earnings, management forecasts, and any other future projections are not considered when making decisions. Earning ability MUST be proven and consistent to spark any interest.
3. Little to No Debt
The bottom line is that Buffett hates debt. The company must be earning solid returns without taking on debt. Debt, while needed in some circumstances, is a profit killer. Let the company pay off its initial debt first and prove itself before placing your first dollar at risk. When in debt, companies can take unwise risks during slow times. This potential simply creates too much risk to make a safe investment.
4. Management
There needs to be an experienced management team already in place before an investment is made. Buffett has no interest in supplying management to run the company. Management should be pedigreed with experience in prior positions or trained from the company itself. Buffett looks for smart, talented people who can solve or better yet avoid problems.
5. Simplicity
You must be able to fully understand the businesses you are investing in. If the company or its business is too complicated, avoid it. Obviously, this rule can be bent as a stock market investor. While it is best to understand a company and its business completely, it’s not a hard and fast rule. This rule goes hand in hand with Peter Lynch’s mantra of buying what you know.
6. The company must be listed with a price
While this Buffet rule is not applicable to average stock investors it is important to understand. Buffett does not buy companies without an asking price. This goes back to belief in only buying sure things. Firms without an asking price require too much negotiation effort to be worthwhile to Buffett. Individual investors can apply this rule by only investing in listed companies. Avoid investing directly in firms that are private or not listed on a stock exchange. While these firms can be wildly lucrative, the unknown risk factors are sky high.
The Take Away
Warren Buffett is the greatest investor of all time. Everyone can learn by studying his investing rules. Make a point of reviewing his past writings and reading his yearly investor letters. The key to his most current wisdom is to avoid companies with debt and to embrace companies with consistent earnings.
FWIW, all of this is how Buffett invests now but of course, most of us don't have a $1bn a month in cash flow to invest.
Buffett DID NOT get rich following the six rules you cite.
He got rich buying crappy companies with weak earnings that had assets he could repurpose and which were cheap to acquire because the business was performing so badly. Unlike the retial investors you are writing for, Buffett invested in businesses where he could get control of those assets and the future investments they would make. He was also really good at picking executive management; many retail investors have never managed a paper bag, let alone supervised executives.
So, cut it with the "invest like Buffett and you too can be a great success" crap.
Here are some other rules about investing like Warren Buffet
1. Read the Buffet Partnership and early Berkshire letters. You will find out that over 65% (two thirds) of his out-performance came from merger arbitrage NOT value investing.
Now how many articles do you see talking about merger arbitrage? Not as many as value investing.
2. The next part of his out performance comes from his clever use of leverage. Insurance. Buffet invests the insurance float (policy holders money), which is the equivalent of a margin loan.
How many articles do you see talking about how to manage investing on margin? Not as many as talk about the principles of value investing.
3. Buffet is a brilliant business man (he figured out pretty early that he had bought a dud with Berkshire and stopped investing most of the operating cash flow back in the business and started putting it into insurance companies.) But if anyone thinks they will get Buffet like performance following the 'rules of value investing' as espoused by Graham, Buffet or anyone else, think again.
4. Buffet used to be a market timer (now he is like a mutual fund, since he is too big to get in and get out). Recall he liquidated the Buffet Partnerships when the market was bubbling. He only buys when 'there is blood in the streets' (buy when others are fearful, sell when they are euphoric) whether you read moods, charts of the tape, the effect it he same.
5. People talk about margin of safety. But Buffet (and Graham) talk about a 30% margin of safety. It is no surprise that the average deep correction is about 30%.
Value investing is great if your really understand it (and have the emotional control to buy when the street is crying). And can deliver overperformance over the long term with lots of drawdowns and periods of under performance inbetween. Most people can not stick with value investing because the drawdowns shatter their confidence.
Great comments.
Great additions.
Putting money and hence encouraging companies that add value to society? Also he adds part of that value generated back into the society through charity work - which is probably the best way to show that it all has to go back into the system at the end of the day and what you have is but choice on how it goes back which Warren does wonderfully.
The reason for the popularity of Oliver Stone's Gordon Gekko character is that he was refreshingly honest about money. No BS about adding value by being a 'capital allocator'.
"The richest one percent of this country owns half our country's wealth, five trillion dollars. One third of that comes from hard work, two thirds comes from inheritance, interest on interest accumulating to widows and idiot sons and what I do, stock and real estate speculation. It's b'sh!t. You got ninety percent of the American public out there with little or no net worth. I create nothing. I own. We make the rules, pal. The news, war, peace, famine, upheaval, the price per paper clip. We pick that rabbit out of the hat while everybody sits out there wondering how the hell we did it. Now you're not naive enough to think we're living in a democracy, are you buddy? It's the free market. " Gordon Gekko
Clarity of thoughts and consistency in thinking is the key to investing, which Warren buffet has mastered.