If He-Man is the master of the universe, Warren Buffett is the He-Man of the investing world.
The only student to get an ‘A’ from his teacher and the father of value investing Ben Graham, Buffett is the most followed and revered investor the world has ever seen. And we are fortunate to have him living in our times.
Often called the ‘Oracle of Omaha’ (Omaha is where Buffett lives in the US), Buffett is the chairman of Berkshire Hathaway, his investment company that was once an ailing textile manufacturer when he took it over.
Buffett’s investment philosophy has been a mixture of Graham and Philip Fisher (another legendary investor), plus his own ideas that he has developed over his investing career.
His principles have worked wonders for him for the past many decades. And he believes that they will still be the cornerstones of investing a hundred years from now as well.
I’d continue this introduction on Buffett, but as his business partner Charlie Munger might bluntly say, “Nobody would listen.”
So without further ado, here are 5 Buffett quotes you should study before making your next investment decision.
We will study the next 5 quotes tomorrow.
1. A public-opinion poll is no substitute for thought.
When in doubt, follow. This is an apt quote on the behaviour of us humans. We generally draw comfort in going with the majority, the public-opinion. The problem is that we have very less control on such behaviour, as evolution has equipped us with this tendency of running a rat race. But the chief problem with this is that even if you win, you are still a rat.
So Buffett advises you to have independence of thought while investing in stock markets. You need to have a deep conviction in any stock you are looking to invest. Don’t go by what others are saying, because others won’t share you losses if they come to haunt you.
Do your own homework. Nothing else matters.
2. If a business does well, the stock eventually follows.
The biggest differentiating trait of Buffett’s own investing philosophy is the clear understanding that stocks are representative of businesses, and not just pieces of paper.
The idea of buying a stock without understanding the company’s business – what it sells, how it sells, how has it grown, how can it grow, is it profitable, how can it improve its profitability, who are its competitors, etc. – is unacceptable.
This mentality reflects the attitude of a business owner as opposed to a stock owner, and is the only mentality an investor should have.
Owners of stocks who perceive that they merely own a piece of paper are far removed from the company’s financial statements.
They behave as if the stock market’s ever-changing price is a more accurate reflection of their stock’s value than the business’s balance sheet, income statement, and cash flows.
For Buffett and all other successful investors, the activities of a stock owner and a business owner are closely connected. Both should look at ownership of a business in the same way.
So if the business grows, the stock will eventually follow.
3. I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.
Buffett follows the concept of ‘circle of competence’ while searching for businesses he would like to invest in. In simple terms, your circle of competence with respect to investing defines your understanding about certain businesses.
The businesses that you understand fall within the circle, and the ones you don’t understand fall outside it. Also, you don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence.
As Buffett says, “The size of that circle is not very important; knowing its boundaries, however, is vital.”
So look for simple businesses that you can understand (the 1-foot bars) instead of worrying about how you can understand a complex business (7-foot bar), when the people running the show themselves don’t understand it!
4. Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.
This happened in 1999, then 2006-07. You know it!
People sold their valuable assets to speculate in stocks just because stock prices were rising as if there was no tomorrow. See what happened thereafter (in 2000 and 2008).
The history of stock markets has enough lessons for investors that the best time to invest in stocks is when others are pronouncing it dead. It is when people call the ‘ice age’ of stock markets – a time when most investors have hidden – that you must be courageous enough to invest.
5. Risk comes from not knowing what you’re doing.
Most investors and their financial advisors would talk about ‘risk’, but very few understand this term. Most believe that risk lies in a stock falling by 20% or more. There are others who think that risk lies in a stock falling at a faster pace than the fall in overall markets.
But as Buffett says, the risk of holding any stock (or for that matter, any investment) is only the ‘permanent loss of capital’.
A permanent loss of capital occurs when a stock goes down because of worsening business operations and stays down for a very long time or even forever. For example, if a company goes bankrupt, or its earnings power drops permanently, then shareholder value will also become permanently diminished.
And investors suffer such permanent loss of capital when they don’t know what they are doing with their savings.
It’s important for you to know what you are getting into – or simply having the understanding of the business whose stock you are buying.
So, I’ll repeat, do your own homework before investing in a stock and buy only when you are convinced that the company isn’t going to go down the drain in the future.
And always remember this – risk comes from not knowing what you are doing, in life and in stock market investing.
Check here tomorrow for five more Buffett quotes that will make you a better, and therefore, richer investor.