Six Keys to Investing Buffett Style
Buying low isn't enough. You need to see the future
The Warren Buffett the world has come to know is a plain-spoken, avuncular figure who seems more at home at a Dairy Queen in his hometown of Omaha than in a boardroom in midtown Manhattan. Think popcorn's Orville Redenbacher, not Wall Street's Gordon Gekko.
And that same homespun charm extends to his investing persona. Indeed, the mystique of Buffett is that this small-town stock picker managed to become America's second-wealthiest man largely by keeping things simple and sticking to his knitting. In Buffett-speak, he stayed within his "circle of competence." For instance, in the late 1990s, Buffett avoided the technology sector altogether, saying, "It's beyond me." But the man who downs five Cherry Cokes a day seems at ease investing in Coca-Cola (Buffett's Berkshire Hathaway owns $9.7 billion in Coke stock).
Yet in reality, Buffett's approach to picking stocks—and businesses to buy outright—has always been far more complicated than Buffett's public image as a "buy 'em at a big discount" value investor lets on. That's because Buffett has never been afraid to deviate from the classic definition of value investing.
As a graduate student at Columbia University in the early 1950s, Buffett learned value investing at the feet of Benjamin Graham, whose 1934 Security Analysis (written with David Dodd) is a value-investing bible. Like Graham, Buffett believes the best way to build a portfolio is to look for stocks trading at discounts to their true worth. Simple enough. But Buffett has made "some adjustments to the teachings of Ben Graham," says Jean-Marie Eveillard, a famed value investor who heads the portfolio management team at First Eagle Funds in New York. Eveillard adds that "there are a few Buffett pronouncements where Ben must be turning over in his grave."
Graham, for instance, never cared much about the quality of the stocks he invested in as long as they were trading at a deep discount to their "intrinsic" value (based on a company's assets and other considerations, as opposed to a stock's market value). Graham described himself as a "cigar butt" investor—willing to buy stocks that Wall Street tossed aside if they had a puff or two of value left in them.
For his part, Buffett is much more concerned about the quality of the companies he searches for in Wall Street's bargain-basement bin, which may explain his reported recent investment in Kraft Foods. "Buffett has said that he would rather own comfortable businesses at a questionable price rather than questionable businesses at a comfortable price," Eveillard says. Or as Buffett has put it: "It's far better to own a significant portion of the Hope diamond than 100 percent of a rhinestone."
Many of today's value managers have come around to Buffett's thinking. "Graham and Dodd wrote the bible of value investing, but there've been other people since who've interpreted that bible," says David Winters, founder of Wintergreen Advisers in Mountain Lakes, N.J. "And Buffett's interpretation has been globally the most influential."
What other attributes define the Buffett school of value investing—and might make you a better stock picker? Here are a half dozen that any do-it-yourselfer will find valuable:
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