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4 Pieces of Warren Buffett’s Best Investing Wisdom

Warren Buffett’s track record as an investor is as good as it gets.

From 1957 to 1969, he was running an investment partnership (what is now popularly known as a hedge fund) in the U.S. and generated a phenomenal compound annual return of 29.5%. For context, the broader U.S. stock market had returned only 7.4% per year on a compounded basis over the same time frame.

But that wasn’t what brought him his world-beater status. What clinched the title for Buffett are his achievements with the U.S. conglomerate Berkshire Hathaway. Buffett first took over the company in 1965 when it was a struggling textile manufacturer (he’s currently still its leader).

Over the years, he has transformed Berkshire through astute acquisitions and smart stock market investments. Most important, he has helped grow the company’s book value per share (a good proxy for its true economic worth) at an annual compound rate of 19.4% from 1965 to 2014. That works out to a total gain of some 751,113%!

Buffett has given many investing speeches in his long career, but my favourite is a 1984 speech titled The Superinvestors of Graham-and-Doddsville. Here are some of what I think are the speech’s best parts, along with my comments.

On what works in investing

“The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market.”

In his speech, Buffett had profiled nine different investors, each with great long-term track records. He pointed out that they had invested in vastly different ways (for instance, some diversified widely while some preferred to concentrate) and in very different stocks (there were no significant overlaps in their holdings). But, there was one common thread which bound them all: They all believed in buying businesses, not tickers.

Successful investing stems from looking at stocks as a piece of a business. Understand this, in my opinion, and you will already have won half the war.

On risk and rewards

“It’s very important to understand that this group had assumed far less risk than average; note their record in years when the general market was weak.”

When I talk to people about investing, they often assume that to get high returns, they must take high risks. But that’s hardly true.

Stocks are risky when they’re being priced high in relation to their intrinsic business values. Their prospective returns are also low in those times since there isn’t an exploitable gap between a stock’s price and its value. On the other hand, stocks are less risky when they’re priced low in relation to their intrinsic values; that’s also when prospective returns are high since the exploitable gap is large.

So instead of “high risk / high returns,” the correct description should be “low risk / high returns.”  The following’s a real-life example of how this works.

On 10 October 2007, when Singapore’s stock market reached a peak prior to the Financial Crisis, the property developers City Developments Limited (SGX: C09) and CapitaLand Limited (SGX: C31) were priced at 3 and 2.7 times their respective book values. Those are high valuations and hence, a risky time to invest. Both stocks are today still down by at least 50% from where they were back then.

On the other hand, in early March 2009, when the stock market had bottomed-out after crashing during the crisis, City Developments and CapitaLand were priced at just 0.7 and 0.5 times their book values. Those aren’t demanding valuations and so, represented a less risky time to invest. Both stocks are now up by 72% and 84% respectively.

On the importance of having room for error

“You also have to have knowledge to enable you to make a very general estimate about the value of the underlying businesses. But you do not cut it close. That is what Ben Graham meant by having a margin of safety.

You don’t try and buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And that same principle works in investing.”

Ben Graham was Buffett’s investing mentor and former boss. In Graham’s classic investing text, The Intelligent Investor, he wrote: “Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” It’s crucial that we leave ourselves enough room for error in our investing activities to absorb the natural vicissitudes of life and the business environment.

On the folly of human kind

“In conclusion, some of the more commercially minded among you may wonder why I am writing this article. Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years, ever since Ben Graham and David Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years I’ve practiced it.

There seems to be some perverse human characteristic that likes to make easy things difficult.”

Investing, at its core, is not something difficult – you buy small pieces of businesses at a price lower than their value, and be patient for that discrepancy to vanish or become smaller. Let’s keep things simple and not overcomplicate matters.

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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.