I think one of the biggest mistakes investors can make when they are looking at the history of Warren Buffett (Trades, Portfolio) is to assume that his investment style has not changed over the past seven decades. That could not be further from the truth. During this period, the Oracle of Omaha has changed his strategy several times in order to keep up with changes in financial markets.
Some might argue the strategy has not changed. It has just developed with the times, which is a perfectly acceptable way of describing it, as long as there is an acknowledgment that he has moved on.
Buffett's mentality has developed in line with the market. This has helped him stay relevant and continue to find investment opportunities rather than being left behind by the rest of the market.
The first change
The first notable transition in Buffett's strategy occurred in the mid-60s. Here, the Oracle of Omaha started moving away from deep value investing, as Benjamin Graham had taught him, to concentrate on "quality" investments.
Before that, Buffett was not averse to taking control of a company and pushing management to unlock value for shareholders. Indeed, that was the case with Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). After buying enough shares of a struggling business, if he didn't get what he wanted, he would take over the business.
It is debatable if Buffett would ever have been able to succeed in his investing career if he had not made this initial transition away from deep value. Buying so-called "cigar butts" had served him well in the past, but finding these opportunities was time-consuming, and the more trades one makes, the higher the likelihood that one will make a mistake. Cigar Butt investing also became a thing of the past as information about companies became more widespread and publicly available.
At the 2017 Berkshire annual meeting of shareholders, Buffett's right-hand man, Charlie Munger (Trades, Portfolio), noted that the duo was "very lucky" to move away from the habit of buying cheap businesses when they did, and the lessons learned have been invaluable:
"We were very lucky that, early, the habit of buying horrible businesses because they were really cheap. It gave us a lot of experience trying to fix unfixable businesses as they headed downward toward doom. And that early experience was so horrible, fixing the unfixable, that we were very good at avoiding it, thereafter. So, I would argue that our early stupidity helped us."
Buffett added that after these experiences, the duo went out "looking for silk," a style that has defined their strategy ever since.
To that, Munger added, "But you have to try it for a long time and fail and have your nose rubbed in it to really understand it."
There are a couple of things investors can learn from this. First of all, it's fine to follow a strategy that works, as long as it works and it is something you are comfortable with. However, the second the strategy stops working, or one becomes uncomfortable with the process involved, changing the style and the system will probably be a better use of one's time rather than trying to make it work.
Still, it is impossible to say when a strategy no longer fits. And this is what Munger seems to have meant with his final comments. One has to really understand why a strategy is not working if one is to draw sensible conclusions. That's what he means by "have your nose rubbed into it." The only way to develop and grow as an investor is to experience uncomfortable situations. These uncomfortable situations help drive change and inspire different ways of thinking.
Investors require a high level of emotional intelligence to understand what went wrong and why the strategy they have been pursuing no longer works. Buffett was lucky enough to realize that what he was doing in the early 1960s had stopped working. Many investors won't have the same kind of realization. Being aware that these things can happen is the first stage of developing the mindset required to overcome the issues.
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