Warren Buffett is one of my investing heroes.
He’s well known for producing incredible long-term returns at Berkshire Hathaway since assuming leadership of the company in 1965. What is less well-known is that he ran his own investment fund from 1957 to 1969 and achieved a stunning annualised return of 29.5%; the US stock market, in comparison, had gained just 7.4% per year over the same period.
Buffett has given numerous speeches and interviews throughout his long career. My favourite is a 1984 speech he gave titled The Superinvestors of Graham-and-Doddsville. I want to share three great lessons I have from the speech.
On what works in investing
Buffett profiled nine investors (including himself) in the speech. These investors invested very differently. For example, some were widely diversified while others were highly concentrated, and their holdings had no significant overlap.
There were only two common things among the group. First, they all had phenomenal long-term track records of investment success. Second, they all believed in buying businesses, not tickers. Here’re Buffett’s words:
“The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market.”
I firmly believe that there are many roads to Rome when it comes to investing in stocks. A great way is to – as Buffett pointed out – look at stocks as part-ownership of a real business. This is what I do too.
On risk and rewards
I commonly hear that earning high returns in stocks must entail taking on high risks. This is not always true. Buffett commented:
“It’s very important to understand that this group had assumed far less risk than average; note their record in years when the general market was weak.”
A stock becomes risky when its valuation is high. In such an instance, the potential return of the stock is also low because there’s no exploitable gap between the stock’s price and its intrinsic value. On the other hand, a stock becomes less risky when it’s priced low in relation to its intrinsic value; this is also when its potential return is high since there’s a wide exploitable-gap. So instead of “high risk / high return,” I think a better description of how investing works is “low risk / high return.”
It’s worth noting that a stock’s valuation is not high just because it carries a high price-to-earnings (P/E) or price-to-sales (P/S) ratio. What is more important here is the stock’s future business growth in relation to the ratios. A stock with a high P/E ratio can still be considered to have a low valuation if its business is able to grow significantly faster than average.
On why sound investing principles will always work
Will sharing the ‘secrets’ to investing cause them to fail? Maybe not. This is what Buffett said (emphasis is mine):
“In conclusion, some of the more commercially minded among you may wonder why I am writing this article. Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years, ever since Ben Graham and David Dodd wrote “Security Analysis”, yet I have seen no trend toward value investing in the 35 years I’ve practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult.”
Surprisingly, it seems that human nature itself is what allows sound investing principles to continue working even after they’re widely known. Investing, at its core, is not something difficult – you buy small pieces of businesses at a price lower than their value, and be patient. So let’s not overcomplicate things, for there’s power in simplicity.
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