Warren Buffett’s Investing Strategy

Virtually everyone – investor or not – knows the name Warren Buffett. Known as the best investor of all time, he’s a household name and the second wealthiest person in the world.

Buffett achieved incredible success as an investor. Can ordinary investors deploy the same strategies as Warren Buffett today to find the same success?

Warren Buffet

Buffett’s Early Years: The Buffett Most Don’t Know

Warren Buffett’s best years were his earliest years when he managed only a small amount of investment capital. His earliest investments were among his least noteworthy. His strategy then, as his partner Charlie Munger often jokes, was to buy companies, remove the cash from the company, and then raise prices.

It was hardly pretty, but it was effective. When Buffett could not own the whole company, he often bought large stakes to seek board seats for him and other investors. Buffett’s ability to influence corporate policy undoubtedly added to his total returns. In several occasions, he purchased shares of companies that sold for less than their net current assets. In effect, he bought businesses for less money than they had in the cash registers – the business was free.

Buffett’s early performance would naturally be the most difficult to replicate. First, it requires a significant amount of money – enough to buy a stake large enough to have influence over corporate decision-making. Second, it requires confidence. At one point, a single company, Sanborn Map Company, made up 35% of his partnership’s investment pool.

In his own portfolio, Buffett was even more aggressive. He admitted later in life that at one point he had 75% of his entire net worth invested in GEICO, then a publicly-traded insurance company. Few investors would tolerate that kind of investment concentration.

Buffett Worked Hard

Replicating Buffett’s work ethic might be the most difficult part of duplicating his early success. This was in the days before computers, when “stock screening” was little more than reading through annual report after annual report. To this day, Buffett is well known for his famous stock screening advice which is to “start with the As” and that the best way to read an annual report is from “front to back.”

His obsession with the markets strained personal relationships, and virtually ended his marriage. Accounts of his earliest days as an investor are littered with references to his constant research – reading nothing but annual reports from dawn to dusk.

The Later Years: The Buffett We Know

After years of investing success and incredible performance, Buffett was exceptionally wealthy. He also managed a very large amount of investment capital. The tiny companies that had made him wealthy were no longer good investments – he simply could not deploy enough capital in each company to make it worth his time.

So Buffett moved on to a “new” kind of investment strategy – buying better companies at higher prices, banking on growth.

He sought out companies that could compound his wealth over time. He favored companies that could retain earnings, and use those earnings to invest in the business for more compounding. Buffett’s willingness to lose money never changed, however. He looked for businesses that could defend against competitors and grow from an “economic moat.”

Replicating Buffett’s Late Performance

Buffett’s later years are undoubtedly the most repeatable by individual investors. His investment goal is to buy a company and hold it forever, preferably buying companies that can reinvest their earnings into future growth along the way.

Here are a few common traits of Buffett’s later investments:

  1. Underappreciated, but simple information – When Buffett invested in Coca-Cola in the 1980s, it was priced for growth – Wall Street knew that Coke would be big. It didn’t know how big. While other investors focused on growth from sales to new Coca-Cola customers in emerging markets, Buffett focused on another important trend: growing per-capita consumption. Not only was Coke growing by selling its product to new customers, it also grew by selling more and more product to the customers it already had.
  2. Reinvestment potential – Buffett looks for companies that can reinvest in their business. He’s not looking for dividends – he wants compounding in perpetuity. McDonald’s, a huge Berkshire holding, could reinvest its earnings to build out new stores and seek new franchisees. The same is true of Walmart, Coca-Cola, and banking giant Wells Fargo, which could reinvest retained earnings to grow their respective businesses.
  3. Economic moats – Buffett looked for companies that had a “moat” to insulate it from competitive forces. Coca-Cola has a distribution network that protects it from a new drink company. American Express and MasterCard have a network that protect their businesses from new card processing competition. GEICO has a moat in being a low cost producer as it does not have salespeople and can sell insurance at a cheaper price than competitors. Wrigley’s has an intangible moat in that is has an established brand.

Being the Second Buffett

Can you be the second Buffett? Unlikely. Few people are willing to ruin a marriage over their investments. Few people will have access to other people’s money and earn management fees like Buffett did in his early years – a variable that put him on track to billions.

Most people will never be billionaires. However, most people, with dedication to their investments, can mimic Buffett’s later investment strategy – buying good businesses insulated from competition with reinvestment potential. It isn’t a matter of intellect, though Buffett is a very intelligent person, it’s a matter of dedication to investment research and analysis.

In Buffett’s own words, “To invest successfully does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework.”

16 Responses to Warren Buffett’s Investing Strategy

  1. It sure would be nice to have the knack for picking out the rockstar companies like Buffet does.. But most of us just don’t have the inside information required to make those determinations..

  2. The very last line in JT’s excellent article holds a big key: keeping emotions out of it. When the markets are high, there is an euphoria that’s hard to escape. It sucks you in and makes you want to buy when what you should be doing in selling.

    Worse: when the economy, and the market, is at its bottom, doom and gloom are everywhere. To go ahead and pull the trigger on the purchase of a rental home or some stocks is one of the hardest things to do. A few years ago, I thought buying a rental home was a great idea. We were drowning in foreclosed homes and every listing was a bargain. When I mentioned it to those around me, every single one, without exception, thought I’d be committing financial suicide. I caved to the emotional pressure, even though I KNEW that would be a terrific purchase. In hindsight, I was right. But I didn’t have the fortitude to overcome the emotional barrier to financial success.

    Keeping our emotions out of our financial decision making is one part of WB’s success that may prove elusive for most people.

    • Definitely! Finding the opportunities is difficult enough, but following through with them (and foregoing all diversification) isn’t easy at all.

  3. I completely agree with William. Key to being successful with investing, much like other things, is keeping emotions separate from investing. I find that having a plan definitely helps with keeping emotions separate from my investments. Buffett also says to buy the fear, which can be difficult to do when everyone else is going the other way.

  4. Man, you make researching companies to invest in sound so sexy, but I bet it’s drier than an Arizona spring. Though, I do know this is a path to successful investing, and most likely I’ll be doing some late-night readin when i decide to jump back in to the investing game…

  5. The key Buffett pointed out was to keep emotions at bay. That is the man cause why so many investors don’t get a decent return. they allow their emotions to come into play and react by doing what they shouldn’t. Most times this is buying high and selling low. Great post on Buffett’s early days and what makes him so great.

  6. I loved this post! I share a similar message to all my college econ and finance classes. It’s really hard to be rational all the time. It gets easier when you create an infrastructure or system to help keep you focused. In the long term the more consistent your behavior the better your odds of coming out on top. I think the most interesting of your three last points are the economics moats. Any time there’s a comparative or even an absolute advantage you are looking at a pretty good situation 🙂

    • The economic moat is the definition of a value investment, heh. I really think it’s much more important to have a knack for microeconomics than it is to understand finance as an investor. Warren essentially proves that true with his ability to sniff out really strong economic moats the rest of the market ignores.

  7. I believe Buffett likes to put on a folksy common sense investing approach is the only thing he does but there are several very complicated derivative investing strategies he is involved with as well.

    His advise is always incredible but after reading the Snowball I believe he is a much different man than the image he has carefully crafted over the years at interviews/speeches.

    He remains one of my all time favorite people!

    • The Snowball is a great, eye-opening book. I definitely saw him in a different light after reading it than I did before. He’s not as “clean” as people think he is, but I guess when you compare him to the rest of Wall Street he’s squeaky clean. 😉

  8. I wouldn’t give up my life and family for billions of dollars, but more power to Buffett! He’s good at what he does and is very driven — two traits that almost always make a person successful.

    • Yes, very, very good – and definitely driven. He basically invested all of his time on earth in the markets, a commitment that nearly all people would never make.

  9. Warren Buffett is no doubt a great investor and has been for many years. That said, he has also had strong underlying cashflows for most of his career (from other business operations like Geico premiums). It is a bit easier to contain your emotions and stay with your process when your biggest problem is finding enough investment vehicles for your cash stash. Interestingly, Buffett himself has lamented the size of his investment vehicles as it places limits on his investment options. In fact, he is quoted as having said that he could return 100% annually on $10MM as opposed to the billions that he manages.

  10. Warren Buffett is my all time favorite personality. I love this strategy to invest. And i have used this strategy to invest my money in USA Graphite Inc. Stocks and i have made more than 100% profit. Thank you sir, keep writing. Cheers!!