In all intellectual pursuits, it pays to study the greats: the people who are widely recognized as the best of the best. In investing, Warren Buffett, legendary value investor and the CEO of Berkshire Hathaway (NYSE: BRK.A, BRK.B), tops that list.
It’s not hard to see why: from 1965 through 2013, Berkshire’s per-share book value (a measure Buffett views as a significantly understated proxy for the company’s intrinsic value) has risen at a compound annual rate of 19.7%, compared to 9.8% for the S&P 500 (with dividends reinvested).
Fortunately for investors, Buffett shares his secrets every year through his annual letter to Berkshire Hathaway shareholders.
“Many people believe reading Buffett’s annual reports is a far better education in value investing than you could possibly get by going to business school and earning an MBA (and a lot cheaper too),” wrote Investing Daily senior editor Jim Fink in a 2010 article.
(On March 1, we published an article examining the highlights of this year’s Berkshire shareholder letter on Investing Daily. Click here to read it.)
Below are five stock-picking tips drawn from Buffett’s shareholder letters and his numerous interviews over the years.
- Strong stocks are worth paying for: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” wrote Buffett in his 1989 shareholder letter.
The idea is that the bargain price probably won’t turn out to be such a steal over time. “For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return,” Buffett wrote. “But the investment will disappoint if the business is sold for $10 million in 10 years and in the interim has annually earned and distributed only a few percent on cost.”
- Patience is crucial: “I call investing the greatest business in the world because you never have to swing,” said the Oracle of Omaha in 1974. “You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”
Buffett repeated this in 1984 and again in Berkshire Hathaway’s 1997 letter to shareholders. When Buffett repeats the same thing over and over again, it’s worth taking seriously.
- Don’t invest in something you don’t understand: “If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter,” Buffett wrote in Berkshire’s 1999 shareholder letter.
“Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter,” he added. “If others claim predictive skill in those industries—and have their claims validated by the behavior of the stock market—we neither envy nor emulate them; we just stick with what we understand.”
For example, Buffett has famously avoided investing in tech stocks because technology changes constantly, making it very difficult for tech firms to sustain a competitive advantage. However, in the first quarter of 2011, he took a 4.5-million-share position in tech mainstay IBM (NYSE: IBM). That holding has since ballooned to 68.4 million shares and 12.8% of Berkshire’s total portfolio.
(Click here to read Investing Daily analyst Brian O’Connell’s recent article on the reasons behind Buffett’s ongoing affection for Big Blue.)
- You don’t have to be a pro to make money in the market: This one goes hand-in-hand with point No. 3. “You don’t need to be an expert in order to achieve satisfactory investment returns,” wrote Buffett in his 2013 shareholder letter.
“But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick ‘no.’”
- Don’t be afraid to bet against the herd: “Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community,” wrote Buffett in his 1986 shareholder letter.
“The timing of these epidemics will be unpredictable,” he added. “And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
During the height of the financial crisis, for example, Buffett made big investments in Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE), the latter of which was being dragged down by big losses at its credit division. Both moves—particularly the Goldman deal—have paid off handsomely for Berkshire.
Do you have any favorite Buffett quotes that aren’t mentioned above? If so, feel free to add them in the comments section.