10 things Buffett does differently

Published on 11/22/19 | Saurav Sen | 1,715 Words

The BuyGist:

  • This short articles is a periodic reminder from us about applying the Buffett method to our investing process. 
  • The tenets are easy, especially once you read them. But applying them is harder. 
  • The path to becoming an Intelligent Investor is laid out clearly for us. Walking it takes practice - a process that can last decades.
  • Constant reminders like this help us stay on course.

Ignore the chatter, minimize costs, and invest as if you would in a farm.

  1. He doesn’t analyze stocks.  He analyzes businesses. 
    • The stock price is an afterthought – just a simple calculation. Analyzing and evaluating a business is hard because it’s subjective. That makes it more laborious. But, what’s the rush?
    • Valuation is just a quantification of a subjective story. It’s not a science. First, get a handle on the story. Numbers are the easy part.
    • Don’t focus on short-cut quantitative metrics like P/E Ratios (the worst of all). They are comforting because they look like “catch-all” numbers. But it’s false comfort.
    • Think about what a company’s competitive advantage is, what the durability of that competitive advantage is, and whether the quality of the management that’s running the show is good enough to ensure the durability of the company’s competitive advantage.
    • “Be a business analyst, not a market, macroeconomic, or security analyst.” – Charlie Munger.
  2. He obsesses over “Economic Moat”. The concept of Moat is usually misunderstood. It’s confused with Competitive Advantage. But Buffett thinks of Moat as a firm’s ability to protect competitive advantage and make it more durable.  
    • Think about current competition and future threats. There will always be threats, but the subjective call is this: will they cut into sales and, eventually, cash flows?
    • “The key to investing,” [Buffett] explains, “is determining the competitive advantage of any given company and, above all, the durability of the advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors. The most important thing for me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.” – from The Warren Buffett Way by Robert Hagstrom.
  3. He doesn’t worry about what the market is saying on any given day. Focus on your data and analysis.
    • “You are neither right nor wrong because the crowd disagrees with you. You are right because of your data and reasoning.” – Benjamin Graham.
    • “Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.” – Warren Buffett.
  4. He doesn’t obsess over forecasting. 
    • Better yet, don’t forecast at all. 
    • Use a probabilistic approach. Subjectively, think about how much revenue and free cash flow the business can generate “sustainably”. Be approximately right rather than precisely wrong.
    • Another method: Roughly back out how much revenue and free cash flow is assumed in the current stock price. Is it reasonable or unreasonable?
      • “Invert, always invert.” – Charlie Munger.
  5. He doesn’t build complicated valuation models. If the math is not easy enough for a simple excel spreadsheet or even a calculator, then put it in the “too hard” pile. It’s probably too close for comfort anyway.
    • “Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.” – Warren Buffett
  6. He thinks “Value-Investing” is a redundant term. If there is no value, why invest? Many people are still stuck in the old Grahamite paradigm of picking up “cigar-butt” stocks when they think “value-investing”. Buffett, thanks to Munger, moved away from that notion since his acquisition of Berkshire Hathaway, which he bought because it was too cheap and not because it was a productive business. Isn’t it ironic? Don’t you think? 
    • “…having started out as Grahamites - which, by the way, worked fine - we gradually got what I would call better insights. And we realized that some company that was selling at two or three times book value could still be hell of a bargain because of the momentums implicit in its position, sometimes combined with an unusual management skill plainly present in some individual or other, or some system or other.” – Charlie Munger.
    • “If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter.” – Warren Buffett.
  7. He’s totally comfortable with holding cash for a long time. There is no need to stay fully invested all the time just for the sake of it. If you don’t find convincing investment ideas, keep the cash. Being “fully invested” is a problem Mutual Funds need to live with; not Buffett and Berkshire.
    • “It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.” – Charlie Munger.
    • “If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they're currently paid - because you'd be holding a block of Wal-Mart and a block of Coca-Cola and a block of something else. You'd be sitting on your ass. And the client would be getting rich. And, after a while, the client would think, "why am I paying this guy half-a-percent a year on my wonderful passive holdings?" So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.” – Charlie Munger.
  8. He doesn’t use Accounting numbers like Net Income or Earnings-per-Share or EBITDA. Use Economic numbers such as Free Cash Flow, or what Buffett calls Owner’s Earnings. 
    1. “Buffett considers earnings per share a smoke screen…To measure a company’s annual performance, Buffett prefers return on equity—the ratio of operating earnings to shareholders’ equity.” – from The Warren Buffett Way by Robert Hagstrom.
    2. “References to EBITDA make us shudder; does management think the tooth fairy pays for capital expenditures?” – Warren Buffett
  9. He thinks about Risk differently. He thinks volatility is a highly flawed measure. It may work for short-term traders but it’s practically useless for long-term investors.
    1. “The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.” – Warren Buffett.
    2. “Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we’re trying to do,” says Buffett. “It’s imperfect but that’s what it is all about.” - from The Warren Buffett Way by Robert Hagstrom.
  10. He thinks Diversification is overemphasized and overdone. 
    1. “What’s wrong with conventional diversification? For one thing, it greatly increases the chances that you will buy something you don’t know enough about. “Know-something” investors, applying the Buffett tenets, would do better to focus their attention on just a few companies—five to 10, Buffett suggests. For the average investor, a legitimate case can be made for investing in 10 to 20 companies.” - from The Warren Buffett Way by Robert Hagstrom
    2. [Most Investment Managers are] in a game where the clients expect them to know a lot of things. We didn't have any clients who could fire us at Berkshire Hathaway. So we didn't have to be governed by any such construct. And we came to this notion of finding a mispriced bet and loading up when we were very confident that we were right. So we're way less diversified. And I think our system is miles better. – Charlie Munger
    3.  “Risk comes from not knowing what you’re doing.” – Warren Buffett…to which I might add, “if you don’t know what you’re doing, you tend to spread your bets more, i.e. diversify.”

It’s not easy to apply all these principles because most of them take a lot of self-discipline and self-awareness. Those are lifelong pursuits. But it is amazing to me how many investors completely ignore these tenets that Buffett has been so generous to share for decades.

The path to becoming an Intelligent Investor is clear. Walking it is hard, but it becomes easier with practice. The time to start practicing is Now.

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