Warren Buffett, Part 1

Is there any way to put a positive spin on the recent dismal performance of the stock market? According to Warren Buffett, there is. He looks at market declines as buying opportunities. In a bear market, stocks are selling at a discount. But is Mr. Buffett’s opinion still relevant? I think so, and if you read on, I think you'll agree.

Warren Buffett is widely regarded as the greatest investor of our time. When he bought the Berkshire Hathaway company in 1965, it was a struggling textile firm. Using Berkshire as a holding company to invest in other businesses, he has parlayed it into one of the world’s most successful enterprises. Had you invested $10,000 in Berkshire stock in 1965, you'd have $51 million today.

How has Mr. Buffett done it? Surprisingly, he’s only too happy to tell you. As Chairman and CEO of Berkshire Hathaway, he writes a letter to his shareholders in each annual report. These letters are remarkably revealing and stunningly forthright, not to mention clear, well-written, and downright funny. They also provide the best guide to investing that I have ever seen. You can find them on the web at www.berkshirehathaway.com/letters/letters.html.

How to Invest

Mr. Buffett states that his goal is to invest in companies that have excellent economic characteristics and exceptional managers. He adds that investments must be made at sensible prices. He prefers companies that are easy to understand and unlikely to experience great change - companies that will remain competitive for at least ten to twenty years. Mr. Buffett invests in these companies either by buying them outright or by purchasing some of their stock. In selecting these companies, Mr. Buffett looks for "economic castles protected by unbreachable moats." In other words, he looks for well-positioned companies with ample defenses to ward off competitors and potential new entrants.

One of the key lessons for the individual investor is that Mr. Buffett evaluates a stock purchase in the same way that he assesses the purchase of an entire firm. He approaches each investment with a healthy dose of skepticism, completely ignoring the cash flow projections prepared by the companies themselves. Instead he performs his own projections of free cash flow to determine whether the company’s expected internal rate of return meets his requirements.

Another important lesson an investor can learn from Mr. Buffett is patience. He asserts that most people would be better off if they were limited to ten investment decisions in their lifetime. This would force them to be very careful with each decision. He further illustrates this point with a baseball analogy. The wise investor should have the discipline to lay off pitches in the dirt or on the outside corner. The goal is to wait patiently for the fat pitch down the middle of the plate.

September 1, 2001

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