Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) leader Warren Buffett (Trades, Portfolio) is considered one of the greatest investors of all time and, arguably, one of the wisest men in history. He loves giving lectures to students as he believes they listen and benefit the most from his talks.
But it is clear that no matter what your age, we can all still learn from the Oracle of Omaha. I have summarized some main takeaways from a lecture he gave at the University of North Carolina in 1996 and expanded with my own comments. This is the first installment of a two-part series that focuses on stock market predictions and Buffett’s simple strategy.
Predicting stock market movements
Buffett admitted to not being able to predict the stock market in the short term or based on economic factors such as interest rates. Rather, he aims to buy businesses that would do well even if the stock market was closed. He does not focus on the daily stock movements and believes the market is there to serve you.
In the past, Buffett has used the allegory of “Mr. Market,” which was created by the father of value investing, Benjamin Graham. The imaginary Mr. Market is a irrational and contradictory person who wakes up extremely optimistic one day and very pessimistic the next.
For instance, imagine you have recently purchased your house for $250,000. A few weeks later, Mr. Market wakes up feeling pessimistic about the housing market and thus offers you a quote for just $125,000; would you sell? Of course not as you know the true value of the house. The next day, however, he offers you $500,000, double what you paid. At that point, you may be inclined to sell as looking around the market, you see you can sell your house for $500,000 and buy another one across the street for $250,000, cashing in a nice profit.
The same is true for the stock market. Each day we are given a quote on a stock which is basically the price people will pay at that time. However, over time, that is not the true value. The true value is derived from the amount of cash flow the business can give off over time, discounted back to today. The moral of the story is not to get caught up in the short term or try to predict the daily moods of Mr. Market through stock market quotes. Ideally, you are looking for the “destination” of the business long term. If earnings will grow long term, then the share price should follow suit.
Invest in simple businesses
Buffett has a common sense approach to investing, which is admired by many. In the words of Charlie Munger (Trades, Portfolio), “Take a simple idea and take it seriously,” which is exactly what he has done.
According to the investor, the goal is to “buy the right kind of business, at the right price, with the right people.” Buffett likes to invest in businesses that are in his “circle of competence.” The important thing is not how wide your circle of competence is, but how well you have defined the edges. For example, Buffett tends to put most technology companies on the “too hard pile” as he finds the economic leaders difficult to predict. This is how Buffett avoided getting butchered during the dotcom bubble and crash of the late 1990s.
A simple business is also easy to run. As Buffett said, “Buy a business any idiot could run because, sooner or later, one will." An example is Gillette, which had a dominant market share and an extremely strong brand. Every man needs to shave and thus, the business' income is perpetual.
Buffett also looks for “one-foot hurdles” to step over and lets everyone else stretch for the hard stuff. His strategy is so simple, but requires immense discipline to implement.
Competitive advantages
Businesses with high returns on capital attract competition, which drives down margins and returns. Thus, Buffett aims to invest in businesses with a competitive advantage or moat.
One type of moat is a strong brand with pricing power, such as Coca-Cola Co. (KO, Financial) or Apple Inc. (AAPL, Financial).
Another example of a moat is network effects, which basically means the more people who use the product, the more valuable it gets. For example, the first telephone was pretty useless as you had nobody to call, but the second made it a little more valuable, then the third and so on. In the modern age, we see Meta Platforms Inc.'s (META, Financial) Facebook has strong network effects thanks to its 2.93 billion monthly active users. However, this still has not been enough to stop competitors such as TikTok, which is rapidly gaining traction with 1 billion monthly active users.
Other examples of moats include lower operational costs, economics of scale (Amazon.com Inc. (AMZN, Financial)) and high switching costs.
Will Buffett split Berkshire's stock?
The investor has been asked for many years whether or not he will split Berkshire's stock.
At the time of the lecture in 1996, the stock price was around $20,000 share. In 2022, it worth over $400,000 per share. Buffett said does not want to split the stock because he wants to attract the right kind of investors. He looks at each investor in Berkshire Hathaway as his “business partners” and wants them to deeply understand his long-term strategy.
Ironically, though, with the invention of fractional trading, anybody can buy a fraction of Berkshire stock, making it seem less expensive to investors.
Buffett on branding
The fact Buffett does not split Berkshire's stock is really a lesson on branding. He wants to put the “right sign” out front to attract the “right crowd” of long-term investors.
For example, if Buffett put a sign outside a lecture hall that said “rock concert,” that would attract a certain crowd. There is nothing wrong with that crowd, but if ballet was actually being performed inside the building, they would be disappointed. This is a great lesson on branding as its all about communicating your business style. Buffett also talked about “franchise value,” which is “in the mind” of the consumer. The real measure of this is whether a customer will pay more for a close to equivalent product. An example is Apple, which has significant pricing power, in addition to See’s Candy and even Coca-Cola.
Final thoughts
Buffett is a truly great investor who takes a simple but disciplined approach to stock picking. He aims to invest in simple businesses with long-term competitive advantages and are run by great people.
The reason most investors fail is they get too caught up in the short-term noise and end up selling at the bottom of the market or buying at the top. Hopefully, Buffett's insight will help you to stay more grounded and keep perspective when investing as, like anything, to be a great investor, you have to continually reinforce positive habits.
