Warren Buffett

Ten great investors

1. Warren Buffett

Job description
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:

1. Simplicity - they are easily understood, and straightforward to manage
2. Strong business franchises - they benefit from 'economic goodwill', i.e. the ability to keep raising prices above the level of inflation
3. Predictability - their earnings can confidently be projected into the future
4. High returns on capital - achieved without resorting to creative accounting or excessive debt. This is even more important than headline earnings.
5. 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.
6. 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."

Further informationBuffett has, alas, not yet written a full-length book of his own. But his annual reports and speeches have been published as The Essays of Warren Buffett (1998). You can also visit his website www.berkshirehathaway.com. The most readable how-to-copy-Warren guide is Robert Hagstrom's The Warren Buffett Way (1994), which he followed up with The Warren Buffett Portfolio (1999). Here in the UK, the monthly magazine Analyst uses stock selection methods modelled closely on Buffett's.

http://www.incademy.com/courses/Ten-great-investors/T-Rowe-Price/1/1040/10002