Warren Buffett (Trades, Portfolio) is a legendary value investor who loves to teach his philosophy to others. One of Buffett’s most iconic lectures was a 2001 talk at the Terry School of Business, which is part of the University of Georgia. I stumbled upon this lecture recently and learned many valuable lessons; here are my key takeaways.
Invest in what you understand
Warren Buffett (Trades, Portfolio) says he has an “old-fashioned” belief that he expects to make money by investing into what he understands. He aims to understand the economics of the business and how that may change (or not change) in 10 years.
The goal with investing is to understand your circle of competence. It does not matter how big or small your circle of competence is, it’s more important to know the limits of your knowledge.
An example of this is Wringley's chewing gum, which is a simple business to understand. In 2001, Buffett stated that the “internet isn’t going to change the way people chew gum,” and he was right.
Despite being long-time friends with Bill Gates (Trades, Portfolio), Buffett famously doesn’t invest in technology companies as to him, it’s hard to pick the winners. He uses the example of auto companies and how the number of them has changed throughout the decades. There were 2,000 auto companies at the start of the 20th ventury, but by the end of that era, only three major players survived. Picking the three winners would have been incredibly difficult, and ironically, even they haven’t done too well. It was actually easier to pick the losers in that sector. This is because, as Buffett said, the “economic characteristics were not easy to define."
Buffett also applied similar reasoning to the airline industry. There were over 400 airline companies in Ohama alone, but they all disappeared. The number of passengers increased every year, but the aggregate earnings of all the companies was less than zero. As we now know, the airline companies would go on to mostly consolidate into a few giants.
We can also apply this to TV manufacturers, as the number of TV sets rose from 6,000 in 1946 to 12 million by 1951, but the majority of TV set manufacturers in the U.S. all went out of business as Japanese companies took over industry leadership.
In the tech bubble of 1999, even if you knew the internet was going to change the world, picking the winners was not easy. However, if we think about Coca-Cola (KO, Financial), which had a winning soft drink product that competitors were unable to replicate, we see one of Buffett's favorite examples of an easy-to-understand company. Founded in 1892, the company was selling 1 billion 8oz servings per day by the year 2000.
How to calculate intrinsic value
The goal of investing is to put money out now, with the plan of getting more money back in the future. Intrinsic value is the value of all future cash flows, discounted back to today. The challenge is forecasting the cash flows and how they may grow.
Buffett suggests thinking about the entire market capitalization of the company and whether you would buy the entire company at the price. The same goes for any financial asset from apartments to oil.
In 600BC, Aesop stated, “A bird in the hand is worth two in the bush." Buffett expands this proverb to “how many birds are in the bush and when can you get them out?" In a humorous manner, Buffett adds, “In the case of many internet companies, there were no birds in the bush," referring to the tech bubble and crash of the year 2002.
The discount rate depends upon interest rates or the risk-free rate, which is usually the 10-year Treasury bond rate. When interest rates are low, the valuation multiple increases, and vice versa. This is why in 2022, with interest rates rising, we have seeing valuation multiples compress.
Investing failures
Buffett is incredibly humble and admits to many failures in the past. Ironically, he says his worse investment was buying the textile mill Berkshire Hathaway, which he has since transformed into a successful conglomerate. The initial Berkshire business was purchased using the deep value or cigarette butt approach to investing. It was selling below net working capital per share and thus was looking cheap. But the business produced poor returns on capital and thus was not great as a long-term investment.
Buffett said that perhaps his biggest mistakes were "acts of omission, not commission." There were great businesses that he knew enough about but didn’t decide to invest in. Buffett suggests being very disciplined and then “grabbing the big opportunities.”
Wonderful businesses
Thanks to Charlie Munger (Trades, Portfolio), Buffett evolved his investing style to focus more on buying “wonderful businesses at fair prices.” These are businesses with characteristics such as high returns on capital and a long growth runway ahead. As Buffett said, “Time is the friend of a wonderful business."
Buffett believe investors should imagine that they have a “punch card” with 20 investment decisions they can make across their whole life. This way, investors will make sure to do enough thinking and research on the companies they decide to invest in.
When to sell a stock
When Buffett started out, he had “more ideas than money." Thus, he had to sell what he liked least to buy something better. But now, Berkshire Hathaway is a global conglomerate, and Buffett’s favorite holding period is “forever," so there's not as much need to sell when better opportunities come along. However, he does still suggest selling if the “economic characteristics have materially changed."
Don't follow the market's mood swings
People tend to be very emotional when it comes to investing. They want to invest when stocks are going up and getting more expensive. In addition, they tend to sell when stocks are going down and getting cheaper. Buffett suggests deattaching your emotions in order to be a successful investor.
Developing great habits
As a thought experiment, Buffett asked his class to identify someone in the lecture hall that they thought would be the most successful so that they could give them 10% of their earnings power forever. Next, he suggests identifying key habits that person has to emulate. He says the most successful people's key traits are not just that “they have the have the highest grades,” but are more likely to be character traits.
Buffett suggests three key traits to look for and emulate in others: intelligence, energy and integrity. It's easier to develop good habits early in life. Conversely, Buffett believes it makes sense to highlight the people you think won’t be successful and the traits they have, then you can aim to minimize those. “The chains of habit are too light to be felt until they are too heavy to be broken.”
Philanthropy
Buffett admires his great friend Bill Gates (Trades, Portfolio) in his approach to philanthropy. Gates approaches investing as a means to help people in the same way as any other business strategy.
Final thoughts
Warren Buffett (Trades, Portfolio) is an incredible investor and one of the wisest people in history. He has the incredible ability to communicate complex topics in an engaging way in order to inspire millions. I highly recommend looking up this Buffett lecture in full for those interested in learning more about this great investor's advice.
