Jim Slater, who was himself a highly influential figure in the world of finance, admires the deceptively simple methods of today's most outstandingly successful private investor.
Buffett: The Making of an American Capitalist
By Roger Lowenstein
Weidenfeld & Nicolson; 473pp; £20
At the last count Warren Buffett, now 64, was worth about $10 billion.
Since 1965 the shares of his company, Berkshire Hathaway, have appreciated at a compound rate of 26.8% per annum. Over the same period the Standard and Poor's 500 Index, including dividends, has compounded at only 9.9% per annum. A sum of $10,000 invested in the S & P in 1965 would now be worth about $160,000. Invested in Berkshire Hathaway shares it would have grown to over $11 million.
Roger Lowenstein's biography, Buffett: The Making of an American Capitalist, explains in an easily read, interesting and entertaining way exactly how the man did it. As Buffett's partner, Charles Munger, says, Buffett's style is 'perfectly learnable'. Munger goes on to explain that other people would not perform as well, but 'certainly better than they otherwise might'.
Before examining Buffett's investment principles, it is important to understand his driving ambition and his early conviction that he would become super-rich. At the age of six he would buy soda pop from his grandfather's grocery store and sell it door-to-door, while other children played in the streets. When Buffett was 13 he had five newspaper rounds and was leaving home at 5.20 every morning to deliver close to 500 papers.
At the age of 11 he bought his first Stock Exchange investment, and by the time he was 14, although still at school, he was earning money at a rate equivalent to the full-time wage of a young man. He was also filing a tax return.
Buffett was reading every available business book and devouring actuarial tables as if they were children's comics. At a very early age he understood the power of compounding. Even then he looked upon every present dollar as having the potential to be worth thousands of future dollars.
It was Benjamin Graham, author of such works as Security Analysis and The Intelligent Investor, who taught Buffett to ignore the gyrations of the stock market and only to buy stocks which had a margin of safety.
Graham's safety margin came from buying shares at a one-third discount to the net current asset value of the company in question - which was amazingly cheap by today's standards. Buffett used this method for several years before embracing the concept of the strong business franchise. Companies such as American Express, Disney and Washington Post were among three of his early successes. As Munger said, 'It was better to pay a fair price for a good business rather than a cut price for a stinker'.
A prime example was Buffett's investment in Coca-Cola in 1988. The company had just sold off some of its non-core activities and was beginning to concentrate on overseas expansion. The shares were quite expensive by his previous standards, being on a prospective price-earnings ratio of 13, but the company's prospects were immense. Buffett saw the potential and bought 7% of the company.
Buffett always tried to invest in stocks with an underlying value greater than the share price. His guide to finding stocks like these, and the other qualities he looked for, are simply explained. Rule one: pay no attention to macroeconomic trends or to people's predictions about the future course of stock prices. Focus on long-term business value - on the likely size of the future stream of profits. As Buffett remarked about forecasting, 'Let me again suggest that the future has never been clear to me. Give us a call when the next few months are obvious to you - or, for that matter, the next few hours.' Rule two: stick to stocks within one's 'circle of competence'. If you do not understand a business, you cannot value the stock. Rule three: look for managers who treat shareholders' capital with owner-like care and thoughtfulness. Buffett particularly liked companies that bought in their own shares and made acquisitions for cash in preference to issuing more paper.
Rule four: study prospects and the competition in great detail. Look at raw data, not analysts' summaries. Trust your own eyes. Buffett has always been a great believer in outsider information.
Before buying American Express, for example, he spent a great deal of time behind the cash desks of local shops and restaurants.
Rule five: run profits and stay with investments and managements that are performing well. This also has the great advantage of saving dealing costs and postponing the payment of capital gains tax. Rule six: the vast majority of stocks are not compelling either way, so ignore them. When an investor has conviction about a stock, he or she should show courage - and buy a ton of it. One of Buffett's most impressive characteristics is his selectivity. He doesn't invest often, but when he does he invests big. He says that an investor should approach the stock market as if he has a lifetime punchcard, and every time he buys he punches a hole. When the card has 20 holes there would be no more investing for life. Obviously, with this kind of limitation investors would filter every idea, only buying into the very best opportunities.
There is nothing to stop private investors developing their own expertise well beyond the average. They should then be able to achieve far better results than the lamentable performance of the majority of professional fund managers. The story of Buffett's success, and the detailed outline of his methods, should be an excellent starting point for them.
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3 Buffett: The Making of an American Capitalist
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4 The Collapse of Barings
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