Editor’s note: This article was first published in February 2014. Buffett’s fortune of 60,000 million (the source gives no currency) and the phrase for more than 50 years are as of 2014.
Invest in great companies with a sustainable competitive advantage, at good prices.
That simple sentence sums up the secret of Warren Buffett’s success as an investor. Put that way, even a fool could get rich. But to understand why people find it so hard to invest like this genius, we need to fully understand a few other messages and connect them to that simple sentence.
An academic study covered in Forbes stressed that once you understand exactly how Buffett’s mind works, luck drops out of the picture completely. There’s nothing magical about it: no tricks, no karma.
Warren Buffett is one of the few people who has amassed a fortune of 60 billion dollars simply by doing, for more than 50 years, exactly what he has told everyone he was doing for those 50 years. Not everyone actually does what they say they do. To understand it properly, let’s break his investment secret down into just two parts:
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What he never did.
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What he always was.
What he never did
To know how someone got where they are, we need to be very clear about what they did to get there. We already know that part, but in this case, what he didn’t do may matter more.
James Berman, president of JBGlobal, recalls the first time he heard of a certain Warren Buffett, through the traditional press. It was in 1973–74, and what struck Berman was that in one of the worst bear markets he had ever seen, with the Dow Jones down 45%, that article by Warren Buffett talked only about investment opportunities in beaten-down stocks, holding on to them and recommending buying them. That clashed with the rest of the analysts’ articles of the time, which talked only about the oil crisis, the war in the Middle East and President Nixon.
Not once did he mention the fashionable profitable investments of the moment, and he didn’t talk about the government. He did, however, go into detail on the micro factors affecting the businesses of the companies he named.
Before long, Berman could see that the recommendations in that article couldn’t have been more on the mark. Even back then, Buffett was known for declaring that he didn’t spend his time on macroeconomics or waste energy trying to guess what the markets would do.
Even so, trying to predict market moves is a mistake that even Warren Buffett’s most loyal followers keep making (and I admit I make it too).
One thing is clear here: if Buffett had let himself be swayed by even a little macro, he would never have had the success he has had in investing. He would have been just another investor.
The main reason most people don’t make money in the stock market is that they follow the red herrings Buffett ignores. James Berman gives a very clear image of who Buffett is: he is the gifted child at a magic show who doesn’t fall for the misdirection and keeps his eyes on the trick itself. In other words, he always focuses on what really matters, while everyone else focuses on the market’s distractions.
What he always was
Everything suggests that Buffett’s skill as an investor has little to do with his financial abilities, and much more to do with his ability as a chief executive. If we extend Buffett’s advice not to invest in businesses you don’t understand, we would conclude that Buffett wouldn’t invest a single euro in a company he wasn’t capable of running.
In fact, when Buffett invests those huge sums in a handful of companies, he advises the companies he invests in, and that’s how he makes sure he gets a return on his investment.
If we split Berkshire’s returns between its investments in listed companies and the private companies it acquires and runs under the Berkshire umbrella, they are exactly the same. So it’s clear that his investing ability lies in his vision as a manager and his knowledge of how to run businesses.
That’s why most investors fail to match Buffett’s returns: they usually study everything to do with the stock market, but find topics like human resources and business leadership boring.
If you want to be a good investor, you need to be a great businessperson, and if you want to be a great businessperson, you’ll need to understand investing. Managing and understanding a business is the “wax on, wax off”: boring at first, but it lays the foundations of what will later become your skills in these seemingly different but completely connected fields.
In short, Buffett has succeeded as an investor because “stock market finance” took a back seat to management, administration, leadership and finance applied to business. What Buffett has really always been is an expert in running companies, and that’s why he only invests in companies that even an idiot could run, because, as Buffett himself has said, sooner or later an idiot will run them.
Further reading
Featured image: David Falconer, Public domain, via Wikimedia Commons.
