Despite Berkshire Hathaway’s modest performance over the last decade, Warren Buffett has a lot of fan following. Many investors would want to follow the legendary investor’s investment style. But then, looking at Berkshire Hathaway’s portfolio, there is no secret recipe of stock selection. While I have used the word “stock” Buffett sees them as companies!
There are literally no rocket science companies in Warren Buffett’s portfolio, but the boring banks and consumer product companies. Apple may be an exception as it may appeal to millennials and baby boomers alike. To sum it up, Warren Buffett’s stock picks have been ordinary companies and many of us would have them in our portfolio. So, what separates Buffett from other fund managers who supposedly use advanced stock screening tools to invest.
Warren Buffett hasn’t followed the herd. He did not jump into tech shares in the 90s although that meant short term underperformance. But then, as the dot com bubble burst, Berkshire outperformed the markets in 2000. Last year also, Warren Buffett preferred to sit on cash even as US stock markets surged to record highs. Many of us knew that valuations were getting ahead of themselves but no one wants to miss the rally even if it’s the last leg. Fund managers are judged by their returns versus the index. Sitting on cash in a rising market is a sure shot way to underperformance. But then, unperturbed by short-term underperformance, Warren Buffett choose to play it safe.
One of Warren Buffett’s famous quote says, “Be fearful when others are greedy and greedy when others are fearful.” Again, it’s easier said than done. A lot of us buy the boom and sell the bust while it’s the opposite that we should be doing. Time horizon is again something that sets Buffett apart. For Buffett the holding period is forever. This however does not mean that he does not sell stocks. This means that you should not panic if a stock you own falls in the short-term. While quarterly earnings make good news, look at the bigger picture. A quarter or two of performance should not guide your investment decisions. Mentally, you should think like business owners. But then not many of us actually think like business owners. Also, not many of us go through annual reports to understand the business.
Warren Buffett does not worry about short-term underperformance and is humble to admit mistakes. His investment strategy is to invest in business that he understands. Again, not many of us want to understand the business before investing. While its not rocket science but somewhat boring and time consuming. Again, Buffett has his own way of valuing stocks and looks for “margin of safety.” The valuation is based on a long-term horizon and not the typical one year forward multiples that many of us look at. For earnings too, while many of us are impressed by numbers like EBITDA and adjusted EBITDA, Buffett looks at owner earnings. Buffett hasn’t used very kind words for metrics like EBITDA. But then, it’s the favorite metric for some analysts and investors. Again, how many investors look deep into earnings to understand the various “adjustments.”
To sum it up, following Warren Buffett is not tough. It would however require a change in our temperament. While you need now know every company and business, invest in companies that you understand. Finally, don’t let the short-term volatility guide your investment decisions.
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