Warren Buffett: 3 Essential Lessons on Investing

Warren Buffett’s one man whom students of the investing game ought to listen to. Having assumed leadership of Berkshire Hathaway in 1965 when it was just a struggling textiles maker, Buffett has transformed Berkshire beyond recognition over the years through astute acquisitions of companies and smart investments in stocks.

Berkshire is today, with Buffett still at the helm, a US$330 billion conglomerate that has seen its book value per share (a good proxy for its real economic worth) grow at a compound annual rate of 19.4% from 1965 to 2014.

In 1991, Buffett had given a series of lectures and transcripts of them had been compiled and kept by fund manager Whitney Tilson. Here are three important lessons about investing I’ve picked up from the lectures (emphases are mine), along with some of my comments.

On what works in investing:

“But Phil Caret has got a record of 70 years. That is a lot of investments and it is a superior investment record. Not done exactly the same as Graham, but it’s the same general approach. Even Keynes came to that view. He started out as a market timer. But in the ‘30s he [changed approaches].”

The “same general approach” Buffett talked about involved having patience, looking at stocks as a piece of a business, and ascribing a value to that business based on factors like its assets, brands, management etc.

Meanwhile, the “Keynes” Buffett referred to above is none other than John Maynard Keynes, an intellectual giant in the field of economics and a person who’s widely regarded as one of the best in the business. Keynes’ evolution as an investor had been documented in a paper published in 2013, titled John Maynard Keynes, Investment Innovator, by finance professors David Chambers and Elroy Dimson.

For most of the 1920s, Keynes’ investing approach was described in the paper as “using monetary and economic indicators to market-time his switching between equities, fixed income, and cash.” It fared poorly, with Keynes losing to the market. From the 1930s onward, Keynes changed course, and started long-term investing in stocks with high dividend yields and good businesses. The results improved markedly.

In the paper was a Keynes quote which read:

“As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.”

Keynes’ experience can be an illustrative example of what works in investing: Having a long investing time-horizon and looking at stocks as a piece of a business.

On what makes a good business:

“A couple of fast tests about how good a business is. First question is “how long does the management have to think before they decide to raise prices?” You’re looking at marvelous business when you look in the mirror and say “mirror, mirror on the wall, how much should I charge for Coke this fall?” [And the mirror replies, “More.”] That’s a great business.

When you say, like we used to in the textile business, when you get down on your knees, call in all the priests, rabbis, and everyone else, [and say] “just another half cent a yard.” Then you get up and they say “We won’t pay it.” It’s just night and day.

I mean, if you walk into a drugstore, and you say “I’d like a Hershey bar” and the man says “I don’t have any Hershey bars, but I’ve got this unmarked chocolate bar, and it’s a nickel cheaper than a Hershey bar” you just go across the street and buy a Hershey bar. That is a good business.

The ability to raise prices – the ability to differentiate yourself in a real way, and a real way means you can charge a different price – that makes a great business.

Not all great investments come from companies that have pricing power in their businesses. But, it’d still pay to sit up and take notice of such companies because they may very well end up as great long-term compounders.

One risk to note with companies that have pricing power is their industry dynamics. I can illustrate this with Sarine Technologies Ltd (SGX: U77). The company makes and sells systems and products which help diamond manufacturers (the ones who turn rough stones into polished gems) greatly improve the efficiency of their operations. Sarine Technologies is an innovative leader of that niche market with a 70% market-share, so that likely confers pricing power to it.

But, the diamond industry has been in a rough spot over the past year, leading to lesser demand for Sarine Technologies’ wares from diamond manufacturers. The company’s business and stock has suffered as a result.

On the importance of having a great consumer brand:

“You really want something where, if they don’t have it in stock, you want to go across the street to get it. Nobody cares what kind of steel goes into a car. Have you ever gone into a car dealership to buy a Cadillac and said “I’d like a Cadillac with steel that came from the South Works of US Steel.” It just doesn’t work that way.”

Having a great consumer-facing brand is not the pre-requisite for a company to become a strong long-term investment. But, it does help. This is also a continuation of Buffett’s second-lesson above. When looking for investing opportunities, ask if a company’s a price-taker, or price-giver; the former group may still be good investments, but we’d have to be more cautious with them.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway and Sarine Technologies.