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How to Make 50% a Year like Warren Buffett

May 09, 2008
Warren Buffett achieved 50% return on small amount of capital during his early years. When asked about how he would try to do that again today, he shared the following tips:

Focus on things that are knowable and important.

Mr. Buffett wouldn't care about a possible recession; He wouldn't spend a minute thinking about it. The next 20 years should be good; He is in the investment game forever. He focus on things that are knowable and important. He doesn't know how to forecast, it's meaningless to him.

Win by playing your game or finding weak opponents.

Mr. Buffett looks at himself as a golfer. "We don't know which holes will come and in what order, but over 18 holes, we will win by playing our game or finding weak opposition," said Mr. Buffett. Look at See's Candy, Coca-cola – nothing else is in your mind when it comes to candy or soda. Share of mind equals share of market.

Capitalize on small capitalizations and human emotions.

In 1998, people behaved like frightened cavemen (referring to the Long Term Capital Management meltdown). They will be frozen by fear, excited by greed and it doesn't matter what are their IQ's and degrees, etc. Growth of 50% per year is achieved with small capitalization stocks, not large caps. It's just capitalizing on human behavior. It's human emotion that creates opportunities when people are frozen by fear or excited by greed. Human behavior allows for success if you are able to detach yourself emotionally. (That's where Zenway Retreat comes into the picture.)

Seek out publishers of stock information and look for various investment guides.

Go through every investment manual page by page. Looking at a copy of the 1951 Moody's, on page 1433, there's a stock you could have made some money on. The EPS was $29 and the Price Range was from $3-$21/share. On another page, there is a company that had an EPS of $29.5 and the price range was $27-28, one times earnings. You can get rich finding things like this, things that aren't written about. Or you can look through investment guides on Korean stocks like Mr. Buffett did.

Look for simple things that can't go wrong.

"In your investing life, you will have several opportunities and one or two that just can't go wrong," said Mr. Buffett. For example, in 1998 the NY Fed offered 30-year treasury bonds yielding less than the 29-½ year treasury bonds by 30 basis points, because Long Term Capital was trying to get out of a highly leveraged trade. In a situation like that, he would jump in with 75% of his networth if he had only a small amount of capital.

It is hard to stick to the basics everyday while finding nothing exciting.

Based on my personal experience with investing and Zen training, the key is to labor through the boring searches with unrelenting attention like a Zen monk day-by-day and suddenly catch the rare moment when other people's attention is slipping away or they are distracted by the emotions and sensations at the time. It is only during those brief and rare moments when you will catch the Warren Buffett type of simple stuff that can't go wrong. So sticking to the simple stuff is not easy. But if you try to be a little smarter, you may end up a lot dumber, said Mr. Buffett. At Zenway.com, we try very hard just to stick to what is simple and understandable. This alone is no easy feat since the human mind tends to wander.


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Brian Zen is Founder and Chief Investment Officer of Zenway.com Inc., a New York-based registered investment advisory firm. He also serves as Director of Research at Superinvestor.net, a collaborative research co-op for investment advisors and aspiring investors. Previously, he served as Vice President at JPMorgan Chase and Janney Montgomery Scott. Brian holds a Chartered Financial Analyst (CFA)® charter and a Master of Business Administration degree in financial accounting from Bernard M. Baruch College, where he graduated suma cum lauda. He is also a graduate of the executive program in value investing at Columbia Business School. Brian is a member of New York Society of Security Analysts and a faculty member at the graduate school of St. John's University teaching investment research.


About the author:

Dr. Zen
Brian Zen, CFA, PhD, author of "Superinvestor Lecture Notes", serves as Chief Investment Strategist at Zenway Group, a New York-based registered investment advisory firm providing asset management services, training Certified Securities Appraisers (CSA), and teaching Graham-Buffett Value Investing. Previously, Brian served as vice president at JPMorgan Chase and portfolio manager at Prudential-Bache Securities and Janney Montgomery Scott, while teaching graduate-level investment analysis at St. John's University. Brian was a Bernard Baruch Fellow and graduated summa cum laude from Bernard M. Baruch College. He is also a graduate of Columbia University's executive program in value investing. Brian appreciates your feedback at: bzen@zenway.com

Visit Dr. Zen's Website


Rating: 3.4/5 (26 votes)

Comments

itznuthin1
Itznuthin1 - 6 years ago
great article, all nuggets of wisdom from Mr. Buffett are valuable.
Laud12345
Laud12345 - 6 years ago
"For example, in 1998 the NY Fed offered 30-year treasury bonds yielding less than the 29-½ year treasury bonds by 30 basis points, because Long Term Capital was trying to get out of a highly leveraged trade."

What kind of trade would you have to make to money on that situation?
mdodson
Mdodson premium member - 6 years ago
Who publishes manuals anymore other than Valueline? esp on an international level and/or on under-followed small caps?
dmangan
Dmangan - 6 years ago
The difference in treasury yields was what LTCM was trying to exploit and combined with lots of leverage is what brought them down. So like Laud I don't see the relevance of the example. To make money you'd have to short one and buy the other while using massive leverage. Would Buffett have done that?
Sivaram
Sivaram - 6 years ago
Pretty good article, although I think 50% per year returns probably require Ben-Graham-type investing (i.e. buying undervalued and selling at fair value; rather than buying good companies and hold forever).

---

To answer some posters above... based on my knowledge...

Buffett actually bought those under-priced US bonds back in 1998 but I don't remember what his strategy was. I'm not a bond expert but typically you would have to short the overpriced bond and own the underpriced bond to make a profit. In the LTCM case, Buffett (and others) may have simply bought the underpriced bond and held it with the view that prices will hit their fair value within a few years. Since these were highly liquid bonds that were likely to revert to the true value fairly quickly, buying and holding would have worked as well. But as Dmangan points out, I'm not sure you would make any decent amount of money with such a small basis difference.

---

Mdodson, there are many companies that publish stock guides. Even for the US, you still have Mergent (formerly called Moodys) and S&P guides, in addition to the Valueline you mentioned. Foreign markets are tougher to find but you do find guides published by overseas companies or large data publishers. For example, I've been looking at Japan lately and there is a book called Japan Company Handbook that provides basic information on all Japanese stocks. I'm sure there are similar books for other countries. They might be kind of expensive so hitting a large public library is probably the best shot.

One other thing to note is that these days you don't need a physical publication. There are many online websites that provide the same stuff. In fact, some screening sites lets you avoid the painful process of filtering through thousands of stocks (but I haven't found any free screener for foreign stocks :( If anyone has found a website screener for Japanese stocks, let me know please)...
cm1750
Cm1750 premium member - 6 years ago
What are good screeners that people use?
commodity
Commodity - 6 years ago
Look at the Fortune 40

and see how easy it is to get 30% returns.

To get 50% returns you would need

to find deep value small cap value stocks.

Think Pabria .

He made 40% returns.

Then sell them at fair value.

No longterm buy and hold.

Buy a basket of cheap value stocks.
commodity
Commodity - 6 years ago
You would short the 30 yr bond

as the yield was too low. Yield had to rise.

LTCM had played the yield spread on long bonds.

The spread was too wide and it had to narrow.

They used lots of leverage to turn a small

sure profit into a large one.

They also lost big on some options they had sold.

They also got killed when the short bond

soared in value as a flight to quality

from the Russian bond default.

They had shorted the T bill as a hedge to the

long position on the long bond.

It was a great idea untill the Black Swan showed up.

WEB wanted to buy the trade cheap.

He knew that in time it would pay off big time.

However high leverage and margin calls

caused LTCM not to be able to hold on.
blakeday
Blakeday - 6 years ago
Commodity, are you saying that he would only short the 30 year without hedging? How much leverage do you suppose he used?
blakeday
Blakeday - 6 years ago
Found this Buffett quote on another web site. I would love to find out how much leverage he used...

"We had that situation a few years ago with the 30 year versus 29 ½ year Treasury bonds. Because of less liquidity, the off-the-run bonds were selling for 30 basis points less, which translates into 3% of principal value. LTCM entered the trade at 10 basis points originally, but they overleveraged and were forced to unwind the position. If you went long/short you could make money really quickly."
Lucia Wang
Lucia Wang - 6 years ago
Big brokerage firms publish those guides. Or you have to travel to those nations.
JLAnnello
JLAnnello - 6 years ago
You'd have to go long the 29 1/2 year bonds and the 30 year bonds. They should be worth the same amount, give or take a basis point, and that type of ridiculous spread would have probably closed in days or weeks once normal buying and selling resumed. In the meantime, putting that trade on with modest leverage would have been sure, easy, returns if you were liquid.

Buffett pointed it out to show that even in this day and age of hedge funds galore, investor irrationality and forced selling will cause no lose situations...
JLAnnello
JLAnnello - 6 years ago
Sorry; long the 29 1/2 year bonds and "short" the 30 year bonds. I missed the word in there.
oddlot
Oddlot - 6 years ago
Great post but hopefully the average individual investor isn't attempting to mimic Warren Buffett's strategy much less his returns. He frequently recommends index investing to those of us that can't spend 40+ hours per week studying stock and the market. I agree that you can outperform the market (positive alpha for the win!), but only if you are able to spend a great deal of time and energy mastering and monitoring your strategy. For the rest of us that have a full time job and a family, Index Investing is a great alternative. There's an intro and a full guide at http://www.money-and-investing.com/Best-Index-Funds-b.html. I did love this article though, outstanding investing tips as usual, I wish I had the time to be a value investor. Buffett is an amazing guy, I can't wait to watch whether or not he wins his recent bet against hedge funds.

Cheers,

Odd Lot

http://www.Money-and-Investing.com

slickvguy
Slickvguy - 6 years ago
I agree that you can outperform the market (positive alpha for the win!), but only if you are able to spend a great deal of time and energy mastering and monitoring your strategy.


I am a stong supporter of the vast majority of people investing in index funds or ETFs. WEB's advice, as usual, is spot on.

However, you left out "dumb luck" as a way for some people to beat the market without spending a great deal of time or money. Not sure what the %'s are, but for every X investors who take a ridiculous amount of risk (either knowingly or unknowingly) - there are Y investors that due to the pure randomness of it all make off like bandits.

I've been a financial advisor for almost 20 years. Every now and then we hear a story about a client who took a shot on one stock or another, and rolled a small amount of money into a very large amount. Obviously, it's a lousy strategy, and I don't recommend anyone try it because most of the time you're going to lose those bets. But there ARE winners. heheh.

For example, if someone were to put a large percentage of their portfolio into one the beaten up financials or housing stocks, ultimately they could dramatically outperform the market. Or they could take a big hit.

sabonis
Sabonis premium member - 6 years ago
It doesnt make sense to me to buy an S&P index fund. If its agreed that lower PE or PS or PB stocks outperform the market over time, you can easily find ways to buy a value type index or screen.

If you would just buy a small cap value index, over time you would thump the S&P without having to spend any research time.
batbeer2
Batbeer2 premium member - 6 years ago
Picking your own stocks is more fun.

1) Even if you underperform the fun must be worth something.

2) If you don't start you'll never learn. Maybe you learn that this is not your forte. Well, then you can allways pick a (index)fund and be content. If you don't you'll allways have that nagging feeling, maybe if.....

3) You'll learn a lot about the various different business you would otherwise never have understood or known.

My goal is to perform better than the interst paid by the bank and learn a lot in the proces.

adamcz
Adamcz - 6 years ago
In response to slickvguy, people who make big money on a risky strategy are likely to soon lose it, due to the false affirmation of their strategy. The evidence that they have indicates that they have all the makings of an expert stock picker, so they are likely to make another risky pick with the larger amount of money.
vhira
Vhira - 6 years ago
I like Yahoo free screener. I used to use Reuters Power Screener Lite, but I think it shut down.

If you are a good company investor, this is my favorite screen:

1. ROE >= 12%

2. Est earnings growth over next 5 yrs >= 10%

3. Total debt/equity <= 1.00

4. Forward P/E <= 15


Believe it or not, you whittle 8000 or so companies down to 454 as of today. Some companies that make the screen that I own:

XOM, PM, PCZ, OMC.

Some companies that make the screen that Buffett owns: WMT, COP, BNI, NKE, UNH, WLP, UNP, NSC.

V

slickvguy
Slickvguy - 6 years ago
adamcz,

Exactly. That was one of my points.

But the amusing thing is that it still DOES happen. Also, there are some people who just "quit" after that, never understanding that they were one or two trades away from putting it all back - and then some. lol. There has to be a small number of participants who just luck out - with no real skill, etc., but just fluke it out. And keep it. You can't bet on it. You can't predict it. Yet it's bound to happen. Rather than poo-poo it with righteous idignation, we should laugh and accept it as part of the crazy game we play. There are definitely unskilled idiots who make fortunes by dumb luck. Obviously they are a slim minority, but they do exist.

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