Book Summary: The Warren Buffett Way

In his book Robert Hagstrom researched the investment techniques of one of the world’s most influentual investors.

Important points to remember:

• Warren Buffett stresses that the critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price. He doesn’t care what the general stock market has done recently or will do in the future. He purchased over $1 billion of Coca-Cola in 1988 and 1989 after the stock had risen over five fold the prior six years and over five-hundredfold the previous sixty years.

• One of the principles demonstrated clearly several times in this book is to buy great businesses when they are having a temporary problem or when the stock market declines and creates bargain prices

• “The basic ideas of investing are to look at stocks as businesses, use market fluctuations to your advantage, and seek a margin of safety. That’s what Ben Graham taught us. A hundred years from now they will still be the cornerstones of investing”

• “When investing,” he says, “we view ourselves as business analysts—not as market analysts, not as macroeconomic analysts, and not even as security analysts.”

• The stock market establishes price. The investor determines value after weighing all the known information about a company’s business, management, and financial traits. Price and value are not necessarily equal. As Warren Buffett often remarks, “Price is what you pay. Value is what you get.”

• “It’s bad to go to bed at night thinking about the price of a stock. We think about the value and company results; The stock market is there to serve you, not instruct you”

• “To properly value a business, you should ideally take all the flows of money that will be distributed between now and judgment day and discount them at an appropriate discount rate. That’s what valuing businesses is all about. Part of the equation is how confident you can be about those cash flows occurring. Some businesses are easier to predict than others. We try to look at businesses that are predictable”

• The speculator, he said, tries to anticipate and profit from price changes; the investor seeks only to acquire companies at reasonable prices.

• True investors are calm. They know that stock prices, influenced by all manner of forces both reasonable and unreasonable, will fall as well as rise, and that includes stocks they own. When that happens, they react with equanimity; they know that as long as the company retains the qualities that attracted them as investors in the first place, the price will come back up. In the meantime, they do not panic. On this point, Buffett is blunt: Unless you can watch your stock holdings decline by 50 percent without becoming panic-stricken, you should not be in the stock market. In fact, he adds, as long as you feel good about the businesses you own, you should welcome lower prices as a way to profitably increase your holdings.

• Buffett finds it odd that so many people habitually dislike markets that are in their best interests and favor those markets that continually put them at a disadvantage. They feel optimistic when market prices are rising, pessimistic when prices are going down. If they go the next step and put those feelings into action, what do they do? Sell at lower prices and buy at higher prices—not the most profitable strategy.

• In Buffett’s view, true investors are pleased when the rest of the world turns pessimistic, because they see it for what it really is: a perfect time to buy We don’t have to be smarter than the rest; we have to be more disciplined than the rest good companies at bargain prices. Pessimism, he says, is “the most common cause of low prices. . . . We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.”

• Psychologists call this overreaction bias. Thus if the short-term earnings report is not good, the typical investor response is an abrupt, ill considered overreaction, with its inevitable effect on stock prices.

• Given the documented success of Buffett’s performance coupled with the simplicity of his methodology, the more appropriate question is, why don’t other investors apply his approach? The answer may lie in how people think about investing. When Buffett invests, he sees a business. Most see only a stock price. Statistics from Google indeed reveals that the search term “share price” are used a lot more than terms such as “share value” or “business valuation”. They spend far too much time and effort watching, predicting, and anticipating price changes and far too little time understanding the business they are part owner of. Elementary as this may be, it is the root that distinguishes Buffett.

• In the long run, the market price of a stock should approximate the change in value of the business. However, in the short run, prices can swoop widely above and below a company’s value for any number of illogical reasons. The problem remains that most investors use these short-term price changes to gauge the success or failure of their investment approach.

• Step One: Turn off the Stock Market
  Step Two: Don’t Worry about the Economy
  Step Three: Buy a Business, Not a Stock
  Step Four: Manage a Portfolio of Businesses

More quotes from Buffett:

• “If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period?”Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.” This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.” – 1997 Chairman’s Letter to Shareholders

• “The typical large company has a compensation committee,they don’t look for Dobermans on that committee, they look for chihuahuas.” He paused amid laughter, then added: “Chihuahuas that have been sedated.” – 2004 Berkshire Hathaway annual meeting.

• “I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”

• “We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

• “Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.” – Berkshire Hathaway 2000 Chairman’s Letter

• “Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”

• “Risk comes from not knowing what you’re doing.”

• Berkshire’s capital base is now simply too large to allow us to earn truly outsized returns. If you believe otherwise, you should consider a career in sales but avoid one in mathematics (bearing in mind that there are really only three kinds of people in the world: those who can count and those who can’t). ” – 1998 Chairman’s Letter to Shareholders

• “I’d be a bum on the street with a tin cup if the markets were always efficient.”