Warren Buffett

Chief executive officer, Berkshire Hathaway Holdings, an investment firm headquartered in Omaha, Nebraska, USA.

Investment style

Originally a value investor interested chiefly in assets, Buffett has since become a long-term growth investor.

Profile

Buffett is a phenomenon. In 1986, he was briefly the richest man in the world, with a net worth of $16bn, thanks entirely to his stockpicking skills and fee income from investment management. He is now worth over $20bn. Yet he started out in 1954 with just $100 to invest. After training as a broker with Benjamin Graham, he founded an investment partnership, with himself as manager. This he ran until 1969, when he disbanded it in the face of dangerously high stock market valuations.

In 1965, he bought ailing textile firm Berkshire Hathaway. It was to become a holding company for a range of investments in media, insurance and consumer companies. He bought many of them at very low prices in the 1973-4 recession. This helped to keep his rates of return well ahead of the market during the Seventies and early Eighties.

Buffett was already a legend in the investment community by the time he bought a huge stake in Coca-Cola in 1988. But it was not until the success of that purchase that he became a folk hero too. He has since become a symbol of all that is best about the old-fashioned, down-to-earth values of mid-Western America. A gift for witty anecdote and example, displayed in college lectures and annual reports, has helped to spread his reputation far beyond the confines of Wall Street and the happy band of investors he has turned into millionaires.

Long-term returns

Buffett is widely regarded as the most successful investor of all time, with a compound return of around 22.3% over 36 years.

Biggest success

Buffett's purchase of Coca-Cola has made his investors a profit of around 800% over 12 years. Less well-known is his investment in advertising group Interpublic in 1973, which brought gains of over 900% in a little over 11 years.

Method and guidelines

Shares are not mere pieces of paper. They represent part-ownership of a business. So when contemplating an investment, think like a prospective owner. Focus on the underlying business, not the stock. What does it do? How well does it do it?

Stick to businesses you understand. Otherwise, you will never be able to grasp the true value of what you own.

There are only a few businesses worth buying. The world is divided into a handful of great businesses and a mass of poor or mediocre ones. Narrow your search down to the former.
"An investor should act as though he had a lifetime decision card with just twenty punches on it. With every investment decision his card is punched, and he has one fewer available for the rest of his life."

The best businesses are like toll bridges, which their customers have to pay to cross if they want to reach their destination. This enables them to piggyback on the growth of other, less fortunately placed businesses.

Most companies have to advertise to make their customers aware of their products and services, which means advertising companies cream off a steady percentage of their sales growth in the form of fees.
Most men have to shave their faces daily, and most women shave their legs. As the world's leading producer of razors, Gillette has a lock on a market that will never disappear, and is expanding in line with the world's population.

Great businesses enjoy the following characteristics:

Simplicity - they are easily understood, and straightforward to manage

Strong business franchises - they benefit from 'economic goodwill', i.e. the ability to keep raising prices above the level of inflation

Predictability - their earnings can confidently be projected into the future

High returns on capital - achieved without resorting to creative accounting or excessive debt. This is even more important than headline earnings.

Strong cash generation - they throw off cash and do not require heavy reinvestment in assets simply to stay in business, enabling them instead to invest the cash in pursuit of even greater profits.

Devotion to shareholder value - the management has a significant amount of its own capital tied up in the business, and thinks of shareholders as fellow owners whose interests are identical to their own.

Estimate the intrinsic value of the business. Price is what you pay, value is what you get. Allow a sufficient 'margin of safety' between the two, so that, in effect, you are paying 50p or 60p for £1 of value. That way, you will still be able to make a good return if your estimates err on the high side.

Buffett uses a calculation known as 'discounted cash flow', or DCF for short. This involves estimating the future cash flows of the business, and discounting these back to a present-day value by applying the rate of return you could otherwise get, with no risk, by putting your money into a benchmark bond, say 10-year UK gilts. This shows whether there is a gap between the current and projected values of the business which is wide enough to give you your margin of safety.

Click here for an example of a DCF analysis of Guinness adapted from The Warren Buffett Way by Robert Hagstrom.

Ignore the gyrations of the stock market. Buffett has said that, after buying a stock, he would not care if the market shut down altogether for ten years, since he is sufficiently confident of the intrinsic value of his holdings that he does not need the market to confirm it for him.

Sell only on one or more of the following conditions:

If the company's intrinsic value is not increasing at a satisfactory rate
If the market value of the company vastly exceeds its estimated intrinsic value
When you need the cash to invest in a company that is even more attractive on the basis of the gap between its intrinsic and market values.

Key sayings
"Rule Number One: Never lose money.
Rule Number Two: Never forget Rule Number One."

"Ben Graham said: 'Investment is most intelligent when it is most businesslike.' These are the nine most important words ever written about investing."

"A good business is not always a good purchase, although it is a good place to look for one."

"I would sooner buy a great business at a fair price than a fair business at a great price."

"When a management with a reputation for brilliance tackles a business with a reputation for poor economics, it is the reputation of the business that stays intact."

INTEGRATE

Born: Omaha, Nebraska, in 1930


Affiliations: •Buffett-Falk & Company

•Graham-Newman Corporation
•Buffett Partnership, Ltd.
•Berkshire Hathaway, Inc.

Most Famous For: Referred to as the "Sage" or "Oracle" of Omaha, Warren Buffett is widely viewed as one of the most successful investors in history.

Following the principles set out by Benjamin Graham, he has amassed a personal multibillion dollar fortune mainly through investing in stocks and buying companies through Berkshire Hathaway. Shareholders in Berkshire Hathaway who invested $10,000 in the company in 1965 are above the $50 million mark today. Now in his 70s, Buffett has yet to write a single book, but among investment professionals and the investing public, there is no more respected voice. (To learn more, read Warren Buffett: How He Does It and What Is Warren Buffett's Investing Style?)

In 2006, Buffett announced that he would pledge much of his reported $44 billion in stock holdings to the Bill and Melinda Gates Foundation ($31 billion) and four other charities ($6 billion) started by members of his family. (For more insight, see The Christmas Saints Of Wall Street.)

Personal Profile


Warren Buffett graduated from the University of Nebraska in 1950 with a Bachelor of Science degree. After reading "The Intelligent Investor" by Benjamin Graham, he wanted to study under Graham, and did so at Columbia University, obtaining his Master of Science degree in business in 1951.

He then returned to Omaha and formed the investment firm of Buffett-Falk & Company, and worked as an investment salesman from 1951 to 1954. During this time, Buffett developed a close relationship with Graham, who was generous with his time and thoughts. This interaction between the former professor and student eventually landed Buffett a job with Graham's New York firm, Graham-Newman Corporation, where he worked as a security analyst from 1954 to 1956. These two years of working side-by-side with Graham and analyzing hundreds of companies were instructive years that formed the foundation for Buffett's approach to successful stock investing.

Wanting to work independently, Buffett returned home once again to Omaha and started a family investment partnership at age 25 with a starting capital base of $100,000. From 1956 to 1969, when the Buffett partnership was dissolved, investors, including Buffett, experienced a thirty-fold gain in their value per share. Prior to the final decision to liquidate the partnership, Buffett had acquired the unprofitable Berkshire Hathaway textile company in New Bedford, Massachusetts, in 1965. After acquiring Berkshire, Buffett effected a successful turnaround of the company, which focused on changing the company's financial framework. Berkshire kept its textile business, even in the face of mounting pressures, but also used the company as a holding company for other investments.

It was in the 1973-74 market collapse that Berkshire got the opportunity to purchase other companies at bargain prices. Buffett went on a buying spree, which included an investment in The Washington Post. The rest is history and today, Berkshire Hathaway is a massive holdings company for a variety of businesses with assets and sales totaling, approximately, $240 billion and $100 billion, respectively, for year-end 2006.

Investment Style

Warren Buffett's investing style of discipline, patience and value has consistently outperformed the market for decades.

John Train, author of "The Money Masters"(1980), provides us with a succinct description of Buffett's investment approach: "The essence of Warren's thinking is that the business world is divided into a tiny number of wonderful businesses – well worth investing in at a price – and a large number of bad or mediocre businesses that are not attractive as long-term investments. Most of the time, most businesses are not worth what they are selling for, but on rare occasions the wonderful businesses are almost given away. When that happens, buy boldly, paying no attention to current gloomy economic and stock market forecasts."

Buffett's criteria for "wonderful businesses" include, among others, the following:

•They have a good return on capital without a lot of debt.
•They are understandable.
•They see their profits in cash flow.
•They have strong franchises and, therefore, freedom to price.
•They don't take a genius to run.
•Their earnings are predictable.
•The management is owner-oriented.

Publications

Buffett has not, as yet, authored any books. However, his annual letters to the shareholders in Berkshire Hathaway's annual report are a suitable substitute. Back copies of these 20-page masterpieces of investing wisdom are available from 1977 through 2006 (updated annually) from Berkshire's Website.

•"Buffett: The Making of an American Capitalist" by Roger Lowenstein (1996).
•"Warren Buffett Speaks: Wit And Wisdom From The World's Greatest Investor" (1997)
•"The Warren Buffett Way" by Robert G. Hagstrom (2005)

Quotes

"Rule No.1 is never lose money. Rule No.2 is never forget rule number one."

"Shares are not mere pieces of paper. They represent part ownership of a business. So, when contemplating an investment, think like a prospective owner."

"All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies."

"Look at market fluctuations as your friend rather than your enemy. Profit from folly rather than participate in it."

"If, when making a stock investment, you're not considering holding it at least ten years, don't waste more than ten minutes considering it."