Today we know Warren Buffett (Trades, Portfolio) as one of the world's best investors, who has earned a fortune buying stocks based on detailed fundamental analysis and holding them for many decades.
Buffett's investment strategy has been shaped over years of reading and studying the market. He was also highly influenced by his teacher and employer, Benjamin Graham, at the beginning of his investment career.
Learning from Graham
Buffett went to work for Graham when he left university. The young investor wanted to work with the man who had taught him so much about investing through his teaching and his books.
I recently stumbled across the transcript of an old question-and-answer session with the Oracle of Omaha, in which he said that before he found Graham's work, he used to rely on technical analysis to pick stocks. This is something I've not heard before; I've certainly not heard Buffett say this recently.
Buffett made these comments at Caltech in 1997, when he was asked to explain the main ideas he learned from Graham. Buffett responded:
"Well, the biggest thing was picking up a book when I was nineteen by Benjamin Graham called the Intelligent Investor. I had been interested in stocks since I was six or seven and I'd charted and done all this technical analysis, it was a lot of fun but it wasn't very profitable. I read the Intelligent Investor and it really had three important ideas in it."
Graham's principles
The first of those three ideas was to think of a stock as a piece of a business, rather than a ticker symbol on a screen.
"It is actually buying a piece of a business just like you buy a service station or dry cleaning establishment in your hometown," Buffett explained. However, rather than buying these small-town businesses, you are buying a percentage share in some of the nation's largest blue chips.
The second principal Graham's books taught Buffett is that the market is there to serve you and not to instruct you. You should not let the market drive your emotions and investment decisions.
Instead, investors should seek to take advantage of the irrational nature of the stock market and snap up bargains when they present themselves. What's more, Graham believed that if a stock went down, then it was good news for the company's investors because they could buy more of the business they liked at a much better price.
The third and final principle that the young Buffett learned from Graham is the highly important concept of a margin of safety:
"The concept of a Margin of Safety which he said if you were driving a car or a truck that weighs 9800 pounds and you see a bridge that says limit 10,000 pounds you go look for another bridge that says 20,000 pounds and you only buy securities when you think they are substantially below what you think they are worth."
Buffett said that he first learned these principles when he was 19, and we know that he still follows them today. They have formed the core of his investment thinking for nearly seven decades.
These three principles might seem simple and easy to follow, but the fact that so many investors still struggle to hold stocks with a long-term outlook and view the market as a selection of businesses, rather than a gambling den, suggests that they are not as easy to follow as it may first appear.
Read more here:
- What We Can Learn From Warren Buffett's Two $10 billion+ Mistakes
- Warren Buffett's 1999 Prediction About E-Commerce
- Why It Is Important to Follow Charlie Munger and Break Down Your Ideas
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