Many people know billionaire Warren Buffett as the “Oracle of Omaha”. As one of the most successful investors this century, Buffett is most well-known for using the long-term value investing strategy.
1) Buffett’s Story
From selling gum and soda pop at the tender age of six, to pooling
money to buy his first stock with his sister at 11, Buffett always
displayed a natural touch for investing and entrepreneurship from
a young age. Indeed, he built his first fortune when he was just a
high schooler when he set up a pinball business with a friend.
Buffett meets his mentor, Benjamin Graham
But the start of Buffett’s close ties with value investing began with the book “The Intelligent Investor” by Benjamin Graham – the father of value investing. The tome that shaped his investing framework, it inspired Buffett to further his studies at Columbia Business School, where Graham was a resident teacher.
After graduation, Buffett tried to apply for a job at Graham’s company but was initially turned down. Eventually, however, a 24-year-old Buffett was hired and worked there with Graham for about two years.
The Berkshire Hathaway story
At 29, Buffett also met 35-year-old Charlie Munger. The pair later became partners of the firm Buffett bought into just a few years after meeting Munger – Berkshire Hathaway (NYSE: BRK).
At that time, Berkshire Hathaway was a textile manufacturing company on a steady decline and was an unloved stock that flew under most of Wall Street’s radar. However, Buffett believed the company was undervalued. He bought shares and eventually gained management rights, allowing him to use the company as a vehicle to invest in a stream of insurance and energy-related companies.
Beating the Dow: an annual average yield of about 20%
Since he took over the management of Berkshire Hathaway, Buffett has helped the business achieve an amazing return of approximately 20% per annum over 50 years.
This means that an initial investment of ¥10,000 in 1965 would amount to ¥24 billion by 2015 if you had invested in Berkshire Hathaway, compared to ¥150 million from investing in the S&P 500 index.
2) Buffett’s strategy: Long-term value investing
Buffett’s favoured strategy is long-term value investing. This
basically means he buys undervalued stocks (stocks trading at a
discount compared to the intrinsic value of the company) and holds
them over a really long time with the aim of long-term profits.
Buying stocks cheaper than its true valuation means that prices have the potential to realise its actual valuation over time. However, since prices can remain low for a long time, great patience is required.
Three points to Buffett's “Value Investing”
Here are some key pointers for investors keen on value investing:
(1) A superior company with wide moats
“In business, I look for economic castles protected by unbreachable ‘moats’.”
- Warren Buffett
If you expect to hold the stock over a long period, you definitely need to have a superior business with excellent finances.
How is this determined though? One easy way is by observing monopolies/oligopolies. For credit card processing companies, VISA (NYSE: V) or MasterCard (NYSE: MA) comes to mind, while for the tobacco industry, Altria (NYSE: MO) or Philip Morris International (NYSE: PMI) is a likely candidate.
These companies tend to be stable even during recessions and may withstand price falls better – the company is unlikely to go bankrupt, and the price often recovers. These monopolies have what Buffett terms a “wide moat”, which means its business has a competitive advantage.
(2) Buying opportunities
“Be fearful when others are greedy. Be greedy when others are fearful.”
- Warren Buffett
One obvious buying opportunity is when the market as a whole declines in a recession despite there being no problems with individual companies.
As demonstrated by Buffett, his US$5 billion investment in Goldman Sachs (NYSE: GS), during the 2008 Global Financial Crisis yielded returns of over US$1.6 billion.
Besides recessions, companies may also perform below expectations or experience scandals, causing stock prices to fall. Provided this is temporary, and stock prices are expected to recover, value investors might also look at these situations as buying opportunities.
3) Putting the stock price and business resilience together
“It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
- Warren Buffett
Rather than buying a structurally unsound company cheap, it is prudent to consider whether the company in question can survive these bad times. Case-in-point: American Express (NYSE: AXP), one of Buffett’s most well-known investments.
In the 1960s, the company was involved in a fraud scandal, suffering reputational damage. However, Buffett deemed the business itself fine and decided to invest heavily in it.
Buffett held on to its shares believing that it is a “wonderful company” that has both long-term competitiveness and a reliable management team, which together, could help it generate large returns in the long run.
Time is a valuable commodity for any busy cosmopolitan investor.
The beauty of value investing though is that you do not need to
constantly monitor the market and engage in trades.
Instead, you can carefully select your stocks and hold them for a really long time. This buys time, which is perhaps the most valuable commodity of all.
by Michihiro Soma, Japanese Editor @ FIGS
09 Nov 2018
(Please note that all views expressed in this article are solely my own and do not represent the opinions of FIGS or its related companies)
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