OK, you might not amass $52 billion. But mimicking the master is a start
By Alex Markels
Posted 7/29/07
What if the bottom was falling out of the stock market, and your portfolio had plunged by 10 percent in a week?
And what if one stock, in particular, had seemed like a sure bet when you bought it last month. The company sells something everyone needs, is well managed, and has a consistent track record of growththat is, until it missed Wall Street earnings expectations by a penny and got pounded down by 15 percent in a single day.
Would you:
a) Sell it and curse yourself for buying it in the first place?
b) Sit tight and do nothing until you recover your loss, then sell?
c) Smile and buy more, sure that everyone else is dead wrong?
d) Study and reconfirm your assessment of the company, then smile and buy more?
If you answered "d," you may have a future at Berkshire Hathaway, the financial juggernaut whose 76-year-old chief executive and godhead, Warren Buffett, is searching for a successor. That's because, in addition to the requisite financial smarts, you'll need the sort of temperament to do what the "Oracle of Omaha" has long done best: take advantage of the market's temporary insanity to stock up on sure things at bargain prices.
It's a strategy that has not only helped Buffett become the second-richest man in America, with a net worth of $52 billion, but has also made him the most watchedand copiedinvestor on Wall Street. Politicians from Arnold Schwarzenegger to Hillary Clinton seek to hobnob with him. And no wonder. Whether through Berkshire's spiraling stock price, mutual funds that mimic his strategy, or investors aping his stock picks, Buffett has probably made more money for more stock market investors than anyone else in history. Each year thousands of those winners and devotees make the pilgrimage to Berkshire Hathaway's shareholder meeting in Omaha, turning the event into a celebration of the man and his financial mastery.
Of course, if you're not one of those people (or you answered "a," "b," or "c" to the above question), fear not. In the following pages, we tell you what it takes to invest like Buffett, whose strategy goes far beyond the simplistic "buy and hold" approach for which he is famous. For example, although he has described derivatives as "financial weapons of mass destruction" and has bashed hedge funds, Buffett has invested in both over the short term and has made hundreds of millions of dollars in the process.
And while he is perhaps the world's leading expert on managing riska talent honed through his investments in insurance companieshe scoffs at the idea of spreading around your bets. "Diversification is a protection against ignorance," Buffett says of index funds that hold hundreds of stocksa sharp contrast with Berkshire's portfolio, in which the top 10 stocks account for more than 90 percent of its assets. "It makes very little sense if you know what you're doing."
You'll better know "what you're doing" after digesting the following pages, in which we plumb not only Buffett's investing style but also those of fund managers who have learned to tweak it to their ownand their shareholders'advantage. This investing guide marks half a century of Buffett investing and records the ideas of a man whose acumen seems undiminished. Yet even though Buffett says he's in excellent health ("It's amazing what Cherry Coke and hamburgers will do for a fellow," he jokes), Buffett of course admits that he isn't getting any younger. And with no obvious heir apparent in place as Berkshire's next investor-in-chief, it's clear that even longtime Berkshire stockholders will eventually need to start thinking for themselves.
Which, after all, is what made their beloved leader so successful in the first place. And learning to think the Buffett way might even help you land a new job.
How to Make Money The Buffett Way
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nuttachk23
Six Keys to Investing Buffett Style
Buying low isn't enough. You need to see the future
By Paul J. Lim
Posted 7/29/07
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 stocksand businesses to buy outrighthas 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" investorwilling 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 investingand might make you a better stock picker? Here are a half dozen that any do-it-yourselfer will find valuable:
Make money by not losing money. It's an oft-quoted Buffettism: "The first rule of investing is don't lose money; the second rule is don't forget Rule No. 1." Buffett's greatest achievement may be that between 1965 and 2006, through three bear markets, Berkshire Hathaway lost value in only one calendar year, 2001. Even then, it still bested the Standard & Poor's 500 index.
Buffett understood this math foible: If you start with a dollar and lose 50 percent of your money, you'll be left with 50 cents. But then it takes a 100 percent return just to get back to your original dollar. So it's best not to fall into a hole.
Don't get fooled by earnings. Buffett has noted that "most companies define 'record' earnings as a new high in earnings per share." But he says the fact that earnings per share are rising in itself tells you little, because it does not take into account how much shareholders have invested. The more that shareholders invest in a company, the greater its earnings should be.
That's why Buffett favors a different measure of profitabilityreturn on equity. ROE is calculated by taking a company's net income and dividing it by shareholders' equity. Since ROE measures profits as a percentage of what investors actually own, it reveals how efficiently a company's profits are growing.
It's unclear if Buffett demands a minimum ROE among his stocks, but some of his value-investing disciples look for companies with a return on equity of at least 15 percent. Within Buffett's basket of publicly traded stocks, his top holding, Coca-Cola, sports an ROE of greater than 30 percent, Anheuser-Busch tops 51 percent, and American Express 37 percent.
Look to the future. They don't call Buffett the Oracle of Omaha for nothing. While Graham was always reluctant to predict the health of a business, Buffett makes a conscious attempt to identify companies with a good chance of continuing their success 25 years into the future. "Buffett talks a lot about looking through the front window and not through the rearview mirror," says John Rogers, chairman of Ariel Capital Management in Chicago.
Buffett peers into the future partly by attempting to calculate the current value of a company's expected future cash flows. It's his way of assessing a company's intrinsic value. Then Buffett looks for companies selling at a deep discount to that value. Often, Wall Streetor "Mr. Market," as Buffett says, echoing Grahamrealizes its error only after Buffett steps in. For example, Burlington Northern and Union Pacific, two plodding railroad stocks that Buffett recently disclosed owning, saw their shares shoot up more than 18 percent and 34 percent, respectively, so far this year.
But he also has admitted that "anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move." Some investors use Buffett-inspired Web calculators to try to emulate the Oracle, including http://www.moneychimp.com/articles/valu ... t_calc.htm.
Stick with companies with wide "moats." Since it's risky to predict the future, Buffett always talks about favoring companies with wide "economic moats." This doesn't necessarily mean that a company has to have a lock on a product or a market. Coca-Cola, for instance, certainly has competition. But Buffett always looks for companies with long-term competitive advantages that make forecasting safer.
A big reason that Buffett avoided technology stocks in the late 1990s was that he could not identify any firms with a wide enough moat. So when Buffett said the tech sector was "beyond me," he wasn't claiming ignorance. What he really meant was that technological advances in this sector were coming so rapidly that it was impossible to gauge with any clarity which companies and platforms would have a competitive advantage 18 months down the road. This would explain why even blue-chip companies like the networking giant Cisco Systems or the microchip manufacturer Intel never made it into Berkshire Hathaway's portfolio even after their shares took a big hit in the 2000 bear market.
When you bet, bet big. Most value investors are conservative by nature. The average manager of a value stock fund spreads his or her bets among 146 different stocks, according to fund tracker Morningstar. Not Buffett. The $62 billion that he has invested in publicly traded stocks is concentrated in only about 45 names.
His strategy is even more aggressive than this statistic would suggest. His top 10 stock picks account for a stunning 90 percent of his publicly traded portfolio. "This concentration is consistent with what Mr. Buffett has said in the past: 'Don't swing a lot, but if you do swing, swing for the fences,'" says Justin Fuller, a Morningstar senior equity analyst. Or, asks Bruce Berkowitz, comanager of the Buffett-loving Fairholme Fund in Short Hills, N.J.: "Why in the world would you want to invest in your 30th-best idea, as opposed to your best idea?"
Of course, this type of thinking takes moxie. You have to be totally confident that your best ideas will outperform the field. In the right hands, though, this risky approach can work: A quick analysis by U.S. News using data from Morningstar shows that value-oriented stock funds with fewer than 50 stocks have outperformed the average value portfolio with more than 50 holdings over the past one-, three-, five-, 10-, and 15-year periods.
Don't be afraid to wait. If you take big swings in the stock market, as Buffett does, there's a big risk of striking out. Buffett's rule: Don't swing that often. And don't swing at bad pitches.
Buffett has quoted legendary Red Sox slugger Ted Williams: "To be a good hitter, you've got to get a good ball to hit." And until Buffett gets such an investing pitch, he's more than willing to hold cash. "He's understood something that people don't appreciate: Having large amounts of cash doesn't have to hurt your performance," Berkowitz says. "Cash can be a strategic asset." Cash currently represents more than 18 percent of Berkshire Hathaway's investment allocation, according to Morningstar, versus just 4 percent for the typical value stock fund.
This doesn't mean that Buffett doesn't want to maximize his gains at all times. Like Gordon Gekko, he believes "greed is good." But like the quintessential value investor he is, Buffett believes that you have to be patient when exercising that greed. As he has often said, "Be greedy when others are fearful and fearful when others are greedy."
Buying low isn't enough. You need to see the future
By Paul J. Lim
Posted 7/29/07
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 stocksand businesses to buy outrighthas 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" investorwilling 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 investingand might make you a better stock picker? Here are a half dozen that any do-it-yourselfer will find valuable:
Make money by not losing money. It's an oft-quoted Buffettism: "The first rule of investing is don't lose money; the second rule is don't forget Rule No. 1." Buffett's greatest achievement may be that between 1965 and 2006, through three bear markets, Berkshire Hathaway lost value in only one calendar year, 2001. Even then, it still bested the Standard & Poor's 500 index.
Buffett understood this math foible: If you start with a dollar and lose 50 percent of your money, you'll be left with 50 cents. But then it takes a 100 percent return just to get back to your original dollar. So it's best not to fall into a hole.
Don't get fooled by earnings. Buffett has noted that "most companies define 'record' earnings as a new high in earnings per share." But he says the fact that earnings per share are rising in itself tells you little, because it does not take into account how much shareholders have invested. The more that shareholders invest in a company, the greater its earnings should be.
That's why Buffett favors a different measure of profitabilityreturn on equity. ROE is calculated by taking a company's net income and dividing it by shareholders' equity. Since ROE measures profits as a percentage of what investors actually own, it reveals how efficiently a company's profits are growing.
It's unclear if Buffett demands a minimum ROE among his stocks, but some of his value-investing disciples look for companies with a return on equity of at least 15 percent. Within Buffett's basket of publicly traded stocks, his top holding, Coca-Cola, sports an ROE of greater than 30 percent, Anheuser-Busch tops 51 percent, and American Express 37 percent.
Look to the future. They don't call Buffett the Oracle of Omaha for nothing. While Graham was always reluctant to predict the health of a business, Buffett makes a conscious attempt to identify companies with a good chance of continuing their success 25 years into the future. "Buffett talks a lot about looking through the front window and not through the rearview mirror," says John Rogers, chairman of Ariel Capital Management in Chicago.
Buffett peers into the future partly by attempting to calculate the current value of a company's expected future cash flows. It's his way of assessing a company's intrinsic value. Then Buffett looks for companies selling at a deep discount to that value. Often, Wall Streetor "Mr. Market," as Buffett says, echoing Grahamrealizes its error only after Buffett steps in. For example, Burlington Northern and Union Pacific, two plodding railroad stocks that Buffett recently disclosed owning, saw their shares shoot up more than 18 percent and 34 percent, respectively, so far this year.
But he also has admitted that "anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move." Some investors use Buffett-inspired Web calculators to try to emulate the Oracle, including http://www.moneychimp.com/articles/valu ... t_calc.htm.
Stick with companies with wide "moats." Since it's risky to predict the future, Buffett always talks about favoring companies with wide "economic moats." This doesn't necessarily mean that a company has to have a lock on a product or a market. Coca-Cola, for instance, certainly has competition. But Buffett always looks for companies with long-term competitive advantages that make forecasting safer.
A big reason that Buffett avoided technology stocks in the late 1990s was that he could not identify any firms with a wide enough moat. So when Buffett said the tech sector was "beyond me," he wasn't claiming ignorance. What he really meant was that technological advances in this sector were coming so rapidly that it was impossible to gauge with any clarity which companies and platforms would have a competitive advantage 18 months down the road. This would explain why even blue-chip companies like the networking giant Cisco Systems or the microchip manufacturer Intel never made it into Berkshire Hathaway's portfolio even after their shares took a big hit in the 2000 bear market.
When you bet, bet big. Most value investors are conservative by nature. The average manager of a value stock fund spreads his or her bets among 146 different stocks, according to fund tracker Morningstar. Not Buffett. The $62 billion that he has invested in publicly traded stocks is concentrated in only about 45 names.
His strategy is even more aggressive than this statistic would suggest. His top 10 stock picks account for a stunning 90 percent of his publicly traded portfolio. "This concentration is consistent with what Mr. Buffett has said in the past: 'Don't swing a lot, but if you do swing, swing for the fences,'" says Justin Fuller, a Morningstar senior equity analyst. Or, asks Bruce Berkowitz, comanager of the Buffett-loving Fairholme Fund in Short Hills, N.J.: "Why in the world would you want to invest in your 30th-best idea, as opposed to your best idea?"
Of course, this type of thinking takes moxie. You have to be totally confident that your best ideas will outperform the field. In the right hands, though, this risky approach can work: A quick analysis by U.S. News using data from Morningstar shows that value-oriented stock funds with fewer than 50 stocks have outperformed the average value portfolio with more than 50 holdings over the past one-, three-, five-, 10-, and 15-year periods.
Don't be afraid to wait. If you take big swings in the stock market, as Buffett does, there's a big risk of striking out. Buffett's rule: Don't swing that often. And don't swing at bad pitches.
Buffett has quoted legendary Red Sox slugger Ted Williams: "To be a good hitter, you've got to get a good ball to hit." And until Buffett gets such an investing pitch, he's more than willing to hold cash. "He's understood something that people don't appreciate: Having large amounts of cash doesn't have to hurt your performance," Berkowitz says. "Cash can be a strategic asset." Cash currently represents more than 18 percent of Berkshire Hathaway's investment allocation, according to Morningstar, versus just 4 percent for the typical value stock fund.
This doesn't mean that Buffett doesn't want to maximize his gains at all times. Like Gordon Gekko, he believes "greed is good." But like the quintessential value investor he is, Buffett believes that you have to be patient when exercising that greed. As he has often said, "Be greedy when others are fearful and fearful when others are greedy."
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nuttachk23
Built to Make Billions?
Emotional IQ just as important as brainpower for Buffett
By Alex Markels
Posted 7/29/07
To the legions of wannabes hoping to replicate, or at least aspire to, Warren Buffett's success as the world's greatest stock market investor, it's a depressing thought, indeed.
What if the Oracle of Omaha's brain is simply a freak of naturea wondrous but ultimately inimitable web of neurons that somehow allows him to deduce profits like no one else? What if Buffett's $52 billion fortune is all thanks to a rarefied double helix strung with the genes of the resolute Scandinavian forebears on his dad's side and the brainy Estonians and arithmetically inclined Iberians on his mom's?
Consider Buffett's typical day at the offices of Berkshire Hathaway, the company he has run for the past 42 years, and you might throw in the towel right now. The spry 76-year-old arrives on the early sideusually about 8:30 a.m.not to prepare for meetings (he rarely takes them) or check his E-mail (he has no work computer) or even to tally his stock portfolio (there's no Bloomberg terminal or even a calculator on his desk). He doesn't read progress reports from his managers (he discourages them) or study the latest research from the top stock market analysts (he shuns them completely). He doesn't even talk on the phone much, save for the occasional call to his stockbroker, when he might give the nod to buy tens of millions of a company's shares in a single dayall without pumping its CEO for information or getting approval from Berkshire's directors or from anyone else except, maybe, a few words from his longtime confidant and Berkshire vice chairman, Charles Munger.
More than luck. Despiteor, quite possibly, thanks tothe dearth of input, Buffett's results are as impressive as they are his alone. His stock picks beat the Standard & Poor's 500 index in 20 out of 24 years, according to one recent study, and by a margin so wide that its authors conclude that even the rarest of lucky streaks can't explain how $1,000 invested with Buffett in 1956 was worth $27.6 million at the end of 2006.
So what can? To be sure, Buffett possesses one of the keenest intellects in business, with a knack for crunching numbers in his head. "His neurons are really good at thinking in a purely abstract, rational way," says law professor Lawrence Cunningham, author of How to Think Like Benjamin Graham and Invest Like Warren Buffett. "It's a way of thinking in terms of calculations, of instantly recognizing if a company generates profits at a given cost over time. It's something businessmen learn to do before making a capital allocation. But for him, it's an innate apparatus."
Cunningham and other Buffettologists nonetheless doubt that the superinvestor possesses some sort of superhuman intelligence. "If you think he's got different chemicals flowing around in his cranium, you've got it all wrong," says journalist Roger Lowenstein, author of Buffett: The Making of an American Capitalist, in which he makes the case that it's Buffett's strength of character, as much as his smarts, that has made him so successful. "It's a combination of hard work and good judgment, and having the disposition to go with your call whether it's popular or not."
For his part, Buffett has repeatedly discounted the importance of a big brain. "Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ," he says. "Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."
Indeed, Buffett picks stocks not according to some inscrutable, savantlike intuition or some secret set of complex equations. ("Don't do equations with Greek letters in them," he jokingly warns of Wall Street-style derivatives.) Instead, he uses basic arithmetic to help analyze some 300 file-cabinet drawers full of annual reports, 10-Ks, and other readily available company financial documents. Fluent in accounting, Buffett pores over financials in search of the mostly obvious: a track record of high returns on equity capital, low debt, and a consistent, predictable business with sustainable advantageslike Coca Cola's soft-drink franchise.
Staying focused. But it's not just financial intelligence at play here. Buffett has plenty of behavioral intelligence as well, most notably a Zen-like patience to sit on the sidelines while other investors are greedily buying and then to pounce on bargains only after the rest have lost their heads and sold. Indeed, a group of academics called "behavioral economists" points to Buffett as the ultimate example of how a properly trained mind can overcome the sorts of emotions and flawed reasoning that can derail even the brainiest investors. "They buy a stock just because everyone else is but think they can get out before everyone else does, or they get stuck on a price in their head and refuse to budge," says Whitney Tilson, a longtime Buffett disciple and fund manager, of misjudgments like the classic "anchoring" mistake Buffett himself made when he first invested in Wal-Mart stock in the 1980s.
"I set out to buy up 100 million shares, pre-split, at $23," Buffett has said of his strategy. "We bought a little, and it moved up a bit [to $23 1/8], and I thought it might come back [down] a bit." But it never did. And because of what he calls his "thumb-sucking" reluctance to pay even a little more, he figures he lost out on $10 billion in profits.
So how does Buffett avoid repeating such mistakes? First and foremost, says Tilson, "he has the enormous humility to admit when he's wrong, and learn from it, and the enormous self-confidence to recognize that the crowd is almost always right. So you have to wait for the few times that the crowd isn't right to make your move."
And where does all that leave the rest of us? Well, perhaps not as bad off as one might think. For starters, Buffett's straightforward methods for evaluating companies are easy enough to apeif not in one's head, then with the help of a computer. "You just press a button," mathematics professor John Price explains of software he designed to mimic Buffett's criteria for sizing up companies, such as a high return on equity, low levels of debt, and a strong probability of earning at least 10 percent pretax returns. Price readily admits that there are some things his program can't do, like sizing up company management or persuading a gun-shy investor to pull the trigger the day after the market crashes. "But it gives you an extra degree of confidence," he says, "to keep you on the path and stop yourself from getting drawn into the behavioral stuff."
Of course, those who don't trust themselves can still harness Buffett's brainpower by plunking down a mere $110,000 a share for Berkshire Hathaway Class A stock, a bet that value investors like Tilson believe is a sure thing. Using the same standards the master uses to pick stocks, he estimates that Berkshire shares are currently about 30 percent undervalued. "And that isn't even including what Warren Buffett adds to the business," Tilson says. "So having him there is just gravy."
Sounds like a no-brainer.
Emotional IQ just as important as brainpower for Buffett
By Alex Markels
Posted 7/29/07
To the legions of wannabes hoping to replicate, or at least aspire to, Warren Buffett's success as the world's greatest stock market investor, it's a depressing thought, indeed.
What if the Oracle of Omaha's brain is simply a freak of naturea wondrous but ultimately inimitable web of neurons that somehow allows him to deduce profits like no one else? What if Buffett's $52 billion fortune is all thanks to a rarefied double helix strung with the genes of the resolute Scandinavian forebears on his dad's side and the brainy Estonians and arithmetically inclined Iberians on his mom's?
Consider Buffett's typical day at the offices of Berkshire Hathaway, the company he has run for the past 42 years, and you might throw in the towel right now. The spry 76-year-old arrives on the early sideusually about 8:30 a.m.not to prepare for meetings (he rarely takes them) or check his E-mail (he has no work computer) or even to tally his stock portfolio (there's no Bloomberg terminal or even a calculator on his desk). He doesn't read progress reports from his managers (he discourages them) or study the latest research from the top stock market analysts (he shuns them completely). He doesn't even talk on the phone much, save for the occasional call to his stockbroker, when he might give the nod to buy tens of millions of a company's shares in a single dayall without pumping its CEO for information or getting approval from Berkshire's directors or from anyone else except, maybe, a few words from his longtime confidant and Berkshire vice chairman, Charles Munger.
More than luck. Despiteor, quite possibly, thanks tothe dearth of input, Buffett's results are as impressive as they are his alone. His stock picks beat the Standard & Poor's 500 index in 20 out of 24 years, according to one recent study, and by a margin so wide that its authors conclude that even the rarest of lucky streaks can't explain how $1,000 invested with Buffett in 1956 was worth $27.6 million at the end of 2006.
So what can? To be sure, Buffett possesses one of the keenest intellects in business, with a knack for crunching numbers in his head. "His neurons are really good at thinking in a purely abstract, rational way," says law professor Lawrence Cunningham, author of How to Think Like Benjamin Graham and Invest Like Warren Buffett. "It's a way of thinking in terms of calculations, of instantly recognizing if a company generates profits at a given cost over time. It's something businessmen learn to do before making a capital allocation. But for him, it's an innate apparatus."
Cunningham and other Buffettologists nonetheless doubt that the superinvestor possesses some sort of superhuman intelligence. "If you think he's got different chemicals flowing around in his cranium, you've got it all wrong," says journalist Roger Lowenstein, author of Buffett: The Making of an American Capitalist, in which he makes the case that it's Buffett's strength of character, as much as his smarts, that has made him so successful. "It's a combination of hard work and good judgment, and having the disposition to go with your call whether it's popular or not."
For his part, Buffett has repeatedly discounted the importance of a big brain. "Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ," he says. "Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."
Indeed, Buffett picks stocks not according to some inscrutable, savantlike intuition or some secret set of complex equations. ("Don't do equations with Greek letters in them," he jokingly warns of Wall Street-style derivatives.) Instead, he uses basic arithmetic to help analyze some 300 file-cabinet drawers full of annual reports, 10-Ks, and other readily available company financial documents. Fluent in accounting, Buffett pores over financials in search of the mostly obvious: a track record of high returns on equity capital, low debt, and a consistent, predictable business with sustainable advantageslike Coca Cola's soft-drink franchise.
Staying focused. But it's not just financial intelligence at play here. Buffett has plenty of behavioral intelligence as well, most notably a Zen-like patience to sit on the sidelines while other investors are greedily buying and then to pounce on bargains only after the rest have lost their heads and sold. Indeed, a group of academics called "behavioral economists" points to Buffett as the ultimate example of how a properly trained mind can overcome the sorts of emotions and flawed reasoning that can derail even the brainiest investors. "They buy a stock just because everyone else is but think they can get out before everyone else does, or they get stuck on a price in their head and refuse to budge," says Whitney Tilson, a longtime Buffett disciple and fund manager, of misjudgments like the classic "anchoring" mistake Buffett himself made when he first invested in Wal-Mart stock in the 1980s.
"I set out to buy up 100 million shares, pre-split, at $23," Buffett has said of his strategy. "We bought a little, and it moved up a bit [to $23 1/8], and I thought it might come back [down] a bit." But it never did. And because of what he calls his "thumb-sucking" reluctance to pay even a little more, he figures he lost out on $10 billion in profits.
So how does Buffett avoid repeating such mistakes? First and foremost, says Tilson, "he has the enormous humility to admit when he's wrong, and learn from it, and the enormous self-confidence to recognize that the crowd is almost always right. So you have to wait for the few times that the crowd isn't right to make your move."
And where does all that leave the rest of us? Well, perhaps not as bad off as one might think. For starters, Buffett's straightforward methods for evaluating companies are easy enough to apeif not in one's head, then with the help of a computer. "You just press a button," mathematics professor John Price explains of software he designed to mimic Buffett's criteria for sizing up companies, such as a high return on equity, low levels of debt, and a strong probability of earning at least 10 percent pretax returns. Price readily admits that there are some things his program can't do, like sizing up company management or persuading a gun-shy investor to pull the trigger the day after the market crashes. "But it gives you an extra degree of confidence," he says, "to keep you on the path and stop yourself from getting drawn into the behavioral stuff."
Of course, those who don't trust themselves can still harness Buffett's brainpower by plunking down a mere $110,000 a share for Berkshire Hathaway Class A stock, a bet that value investors like Tilson believe is a sure thing. Using the same standards the master uses to pick stocks, he estimates that Berkshire shares are currently about 30 percent undervalued. "And that isn't even including what Warren Buffett adds to the business," Tilson says. "So having him there is just gravy."
Sounds like a no-brainer.