Investing Warren Buffett Way
Investing Warren Buffett Way. If you what to invest like the Billionaire Warren Buffet, Here is the all you need to know:-
Warren Buffett is the leading light for investors worldwide and every word he says is scrutinized and studied by throngs of budding investors. There are endless articles, videos, and newsreels out there featuring the life of Warren Buffett and Berkshire Hathaway. It has reached a point where there are listless citing unverified quotes from Buffett being shared by millions on Facebook. Everyone wants to be a billionaire investor, yet there is only one Warren Buffett and only a handful of billionaire investors that are worth at most half of Buffett’s wealth. This is a sobering shot of reality, buckle up.
It’s great to be motivated by Buffett’s success, but how many out there has the discipline to actually implement good habits and stay within their circle of competence for decades? Moreover, Buffett’s successes in the past can’t really be repeated today as the dynamics have shifted permanently.
A majority of investors assume Warren Buffett got rich by investing in great companies at fair prices, example Coca-Cola, American Express and Wells Fargo. But can a retail investor be made a billionaire by investing in such companies alone ?
Warren Buffett accumulated Coke stock for approximately a billion dollars in 1989. Even if you can find such an enticing company today, where do you find the billion dollars to invest?
For understanding – Investing Warren Buffett Way – Let’s look at Buffett’s early history
Other people’s money ( OPM ) – Investing Warren Buffett Way
The key to Buffett’s wealth and almost every other billionaire is leverage, Buffett is an expert at using OPM (other people’s money). Buffett once famously said that when you buy shares of a company, you become a business owner and that you should ascertain whether its earnings and cash belongs to you. But the crucial difference lies in the often omitted detail of ownership. Buffett often buys the entire company for himself or a substantial shareholding of the company, but you can’t.
Back in the 1950’s, Buffett set up the Buffett Partnership, which was essentially a type of hedge fund (though the term wasn’t widely used at the time). He funded the Buffett Partnership with his own savings and the investments of other associates. Using this structure, he then went out to buy small undervalued companies of which he could take economic control of. Buffett called them “work-outs” where the corporate action was required for the company to unlock value; he was essentially an activist investor.
Value Investing as a retail investor today versus Value Investing in Buffett style (an era of 1958 ) is different. The company you believe to be undervalued would require the management and/or the market to act on its cheapness so that it can unlock its true value. Buffett would simply buy a majority stake and persuade the management to make the changes. A retail investor can only hope for an activist intervention that’s in his favor, but that’s a lousy investment thesis, to begin with.
Imagine buying a stock which has a huge cash balance, which is technically yours, but you own only 0.0000001% of the shareholding. You can’t really do anything with that cash. Further, you certainly can’t force the management into giving it back to shareholders as the company will have to bear dividend distribution tax.
Real Example – Investor Carl Icahn has sent an open letter to Apple’s CEO, Tim Cook, with lots of nice things to say about the iPhone 6 and the Apple Watch. But also this: He’d like shareholders to get paid, please, and faster.
Icahn controls 53 million shares of Apple, worth $5.3 billion, which gives him about a 0.9% ownership in the company. In his letter, Icahn lays out his reasons that Apple should repurchase its own shares.
Carl Icahn managed to force Apple to pay a dividend, but he had to invest more than a billion and use his fame to force management into acting in his favor. The normal retail investors can’t achieve what Icahn managed to do with Apple Inc.
Berkshire Hathaway :- Buffett then dissolved Buffett Partnership and bought out the ailing Berkshire Hathaway company, a process that took years of accumulating its stock in the early 1960’s. By gaining control of the textile company, he used the cash in that company to fund his investment in National Indemnity Company in 1967. This is a classic example of Buffett using OPM to purchase Berkshire, then using the target company’s cash holdings to acquire another company.
As retail investors, is it really that we can go and buy out an entire company and use its cash to acquire others? And that’s assuming that the management will be friendly to a takeover. If you can clear this first hurdle – meaning that you can gather a group of friends or family to co-invest in your fund to buy out an entire company and if you successfully do it then your chances of emulating Buffett just got higher.
Following National Indemnity, Buffett then bought GEICO, Nebraska Furniture Mart and numerous other Companies as a whole, and he was using their cash holdings for swallowing other companies. This is how he turned capital allocation into an art of value investing. Many Investors that have tried to copy his methods have fallen short in achieving the same magnitude of success.
Capital allocation – Investing Warren Buffett Way
Buffett’s perspective on cash and leverage can be understood by analyzing how he invests and rewards shareholders of Berkshire Hathaway. Berkshire has famously never paid a single dividend, but most of its investments do. He has been always against paying dividends as he believes that by reinvesting every single cent into his businesses, acquiring others or buying back shares when Berkshire Hathaway dips below a certain price to book value, it gives shareholders a greater, tax-efficient return on investment. This is true as many early Berkshire investors have become very rich by simply holding on to Berkshire shares.
Buffett basically followed the theory on dividend policy given by Prof. James E. Walter which states that if the company can earn more on the retained earnings compared to cost of capital then optimal dividend payout ratio shall be 0 %. Further Growth of a company is simply a function of retained earnings and the rate at which the company can earn on retained earnings.
There are only a small handful of companies out there (called “Baby Berkshires”) that have been successful at not paying dividends and seeing their stock price compound over a long period of time. As a retail investor, finding such a company is difficult and further having absolute faith in management especially in India is quite a risky call to make. As a small investor, what can you do about it? Shout at management at the AGM? It’s one of the biggest questions investors big and small ask themselves – what kind of reinvestment opportunities would their portfolio or prospective companies ? Do you trust the management to allocate your capital wisely? Do you want Companies to pay back the profits in form of dividends as you believe you’re the better at capital allocation ?
Reliance followed strict dividend policy till the time of Mr. Dhirubhai Ambani as there were many positive NPV projects at hand which would generate more return on retained earnings. But after Mr. Dhirubhai, reliance had to start paying dividends.
Economic growth – Investing Warren Buffett Way
Fact that aided Warren Buffett’s ascendancy is the unparalleled growth of the US economy from the 50s to the 90s. In a slow-growing, mature or stagnant economy, it’s much tougher to achieve outstanding returns at an annual rate of 20% compounded for decades. The size of economy also counts as well – the U.S. economy grew to be the largest economy in the world, the runway for growth is huge for American companies operating within the States itself without having to venture overseas. One can realistically expect an Indian firm to make one, a billionaire now because India’s economy is the fastest growing and the runway for growth unlimited.
Whenever you try to forecast economic growth for a certain country, simply ask yourself this: “What is the basis for my belief that Country X’s economy/stock market will grow X% over the long run?” Question the validity of your assumption. Buffett has repeatedly said that he owes his wealth to him being born at the right time, and at the right place and this is often left out in many articles about him.
Market inefficiencies – Investing Warren Buffett Way
Markets today are way more efficient than the markets during Buffett’s younger years. There was no Bloomberg, Microsoft Office (Excel in particular), Capital IQ nor the Internet. Most analyses were literally done on paper with a calculator and pen. Public information was available, but it was scarce as there was no Google to parse information and keep it readily available. On the other side, global markets have never been as readily accessible as they are now. You can invest almost anywhere in the world without even stepping out of your room. This makes life easier (or tougher) for the budding value investor as there’s no excuse now to miss on any opportunities overseas.
In the 50s, Buffett’s partnerships were perhaps one of the few existing hedge funds in the world.
Now, there are tens of thousands of funds using highly complex (or simple) strategies to hunt inefficiencies in the markets. We can easily find a stock, thanks to Google and can analyze its financial statements using Excel, we can also use various free stock screeners to screen for “value” plays. How many million more people out there can do that in the 50s? The market has gotten more efficient with the ease of access.
Buffett himself no longer invests in public equities as aggressively as before, because Berkshire Hathaway has grown too large to have a small company move its needle. He now hunts the big game – buying out companies in private-equity style to expand the Berkshire Empire.
Compounding habits – Investing Warren Buffett Way
Another key to Warren Buffett’s success is behavioral. Compounding doesn’t just work for interest on money, but on other factors like habits, interest, will, determination, focus and much more.
Buffett has always been interested in money since young, he sold chewing gum and Coca-Cola drinks when he was just six, he then bought his first stock at the age of 11 – purchasing Cities Service at $38 a share, selling it at $40. He then had to watch it painfully rise to over $200.
At the age of 13, he filed his first tax return. Age 15, he delivered Washington Post newspapers and at 17, started a pinball machine business. By the time he was 27, he had studied under and worked for Benjamin Graham and started five partnerships investing his and his clients’ monies.
This is the power of compounding – his voracious appetite for making money since he was six had snowballed into making him one of the richest men in the world. The average retail investor does not have the same habits and reading endless articles on how to change one’s habit wouldn’t help if one doesn’t have the discipline to stick with it for decades. His habits seem easy at first thought, like reading, but imagine doing that for maybe just one month, only few would be able to sustain the intensity.
If you are new to the world of investing then here is the advice by the – Most Successful Value Investor and Billionaire Warrren Buffett.
He said that the best advice he got was from his holy bible, The Intelligent Investor, written in 1949 by value god Benjamin Graham. He further said that, “Chapters 8 and 20 have been the bedrock of my investing activities for more than 60 years,” he says. “I suggest that all investors read those chapters and re-read them every time the market has been especially strong or weak.” – Download.