Warren Buffett strongly instructs us to think for ourselves. He uses his own perspective—acquired from years understanding businesses, his vast knowledge of business—to assess business opportunities, appraise their value, and profit from them. He advocates using our own talents and specialties to invest in the areas of business where we feel most comfortable. He terms the areas of expertise as “the circle of competence.” This concept is a wonderful way for beginners to begin investing in stocks because it limits the list of available options into something that seems much more manageable and affords the investor to grow investing knowledge over time.
In Berkshire Hathaway’s 1996 Chairman’s letter and annual report, Warren Buffett wrote,
To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses—How to Value a Business, and How to Think About Market Prices.
Warren Buffett at all times contemplates a company’s aptitude for growth in the long run. He never invests like traders with short term holding. Warren Buffett would always like to strike “an acquisition deal as if he wants to close it tomorrow and then not to reopen it for the next five years or more.”
On 17-May-1984, in a speech at Columbia Business School marking the 50th anniversary of publishing Benjamin Graham and David Dodd’s Security Analysis, Warren Buffett said,
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.
Investors need to understand the value of a business before they invest. Sound investors evaluate the return on tangible invested capital and the characteristics of a business to generate cash flow over a long term. The 18-Oct-1993 Forbes 400 list of the richest people in America quoted Warren Buffett:
I am a better investor because I am a businessman and a better businessman because I am an investor.
Even if academicians provide students a strong foundation in essential business disciplines and critical knowledge for the investment process, but the thinking they imbibe in students is full of complex financial theories, trading strategies, practices that encourage market-timing , and strategies for investment management and analysis that involve a complexity of macro- and micro-economic factors. From Andy Kilpatrick’s ‘Of Permanent Value: The Story of Warren Buffett’,
We are enormously indebted to those academics: what could be more advantageous in an intellectual contest—whether it be bridge, chess, or stock selection—than to have opponents who have been taught that thinking is a waste of energy?
Jason Zweig, author of the Saturday ‘The Intelligent Investor’ column for The Wall Street Journal quoted Warren Buffett on his principle on trying to understand the businesses he considers investing in:
“We do try to buy our businesses like we buy our stocks, and buy our stocks like we buy our businesses.” By that he means, among other things, that he wants to understand how the enterprise generates cash, how well-managed it is and whether its customers would stay loyal even if it raised the prices of its goods or services. Note carefully: None of these factors are contingent on the current price of the stock.
“Being a businessman makes me a better investor and being an investor makes me a better businessman … Most businessmen limit themselves to their own field, and most investors don’t really think about businesses. And many businessmen are semi-oblivious to the yardsticks other people use outside that field. I’m always comparing everything to everything else. The question I want to answer is. ‘Where do we get the most for our money in something we can understand?'”
Recommended Reading on Warren Buffett & Value Investing
- ‘Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012: A Fortune Magazine Book’ by Carol J. Loomis
- ‘The Warren Buffett Stock Portfolio: Warren Buffett Stock Picks: Why and When He Is Investing in Them’ by Mary Buffett, David Clark
- ‘The Tao of Warren Buffett: Warren Buffett’s Words of Wisdom: Quotations and Interpretations to Help Guide You to Billionaire Wealth and Enlightened Business Management’ by Mary Buffett, David Clark
- ‘The Oracle Speaks: Warren Buffett In His Own Words’ by David Andrews