I’ve read numerous articles over the years claiming you cannot use the same investment strategy as Warren Buffett, plastered all over investment website platforms, and Investopedia is full of these articles.
Those articles were probably a reflection of the author’s own ability, not their readers.
Value Partners Asia ex-Japan Equity Fund has delivered a 60.7% return since its inception three years ago. In comparison, the MSCI All Counties Asia (ex-Japan) index has returned just 34% over the same period. The fund, which targets what it calls the best-in-class companies in "growth-like" areas of the market, such as information technology and Read More
In this article, I will outline the reasons why they were wrong and how you can use the same investment strategy. This article will focus on Buffett’s investment strategy to buy listed stocks and not his strategy for purchasing whole businesses (even through the methods are virtuality the same).
The commonality of the articles is simply this: they confused the following terms objective and tactics with strategy.
Buffett’s wrote in his 1960 partnership that his “continual objective in managing partnership funds is to achieve a long-term performance record superior to that of the Industrial Average.” (Bolded emphasis mine)
And more specifically, investors close to Buffett, have informed me that Buffett will add the yield on U.S. 30 Year Treasury to 7 percent (2.786 % + 7% = 9.80%, rounded is 10%). This is appropriate as to take into account the effect of inflation. In addition, Buffett required a seven year payback period for each individual investment.
That was Buffett’s objective, but what was his Strategy?
Buffett’s wrote in 1958 “I make no attempt to forecast the general market – my efforts are devoted to finding undervalued securities.”
And Buffett has repeated this strategy throughout the years in his Berkshire Hathaway annual letters to shareholders.
It is well known that Buffett has evolved his investment strategy from his early days of picking up cigar butts, undervalued business based upon static valuation ratios, taught to him by his mentor Benjamin Graham.
Too buying undervalued franchised businesses, which exhibit competitive advantages. The two people who helped Buffett evolve his investment strategy in those early days were Charlie Munger and Phil Fisher. All this is well documented in Alice Schroeder’s book, The Snowball: Warren Buffett and the Business of Life.
But Buffett didn’t change any method in his investment strategy that conflicted with the fundamental principles of investing.
For instance, when Buffett learnt about Phil Fisher’s methods for seeking out high [probable] growth stocks, he always made the effort to check that a high growth business was adding value to the bottom line.
In Buffett’s words…
“…most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.
We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).” (Bolding emphasis mine) Source
How does Buffett assess if a growth business is adding value? Read on
Now we know that Buffett’s strategy is to buy undervalued businesses coupled with competitive advantages (or as he refers to them Moats), listed on U.S. stock exchanges, but it was a tactical decision to focus his attention on industries within his circle of competence.
Buffett wrote in 1996, “an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. 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.”
This tactical aspect of the investment strategy is what we cannot copy and use ourselves, which is self-explanatory. This is what those authors were trying to get at, plus of course, we cannot replicate Buffett’s results, again that is self-explanatory.
“Bertrand Russell’s observation about life in general applies with unusual force in the financial world: “Most men would rather die than think. Many do.” Warren Buffett
Watch Fortune Mag interview Jeremy Miller, author of ‘Warren Buffett’s Ground Rules for Investing.’ This book is endorsed by Buffett!
How can you apply the same investment strategy?
Back to how you can determine if a high growth business is adding value to its bottom line.
You want to be checking that its equity is growing. Two places you can check, the first is the businesses Statement of Changes in Equity.
There will be a column called retained earnings, keep an eye on it. It should be growing, and question when they payout dividends.
The second is calculating the return on equity. It requires a few steps, but a simple way to check is to simply divide this years earnings by last years equity total. You should really make adjustments to the earnings to reflect a truer earnings picture.
To learn how to invest successfully, that is make money and limit your risk of losing, really is not as hard as people make out.
Once I learnt the rules of the investing game, I suddenly saw thru the bullshit – marketing & articles – out there.
If you are interested in understanding the underlying investment principles, that will allow you to gain deep insights about how the flow of money between a businesses financial statements – balance sheet, cash flow statement and income statement – adds or destroys value please Click here to check out memberships.