During the 2010 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) Annual Investor Meeting, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) were asked how investors can get better at valuing a company. We have heard the famous quote by Oscar Wilde: "A cynic is a man who knows the price of everything and the value of nothing." Improving valuation skills is critical to taking advantage of mispricings. So how did these two investors improve their skills over time?
Buffett: Very, very good question. I started out not knowing anything about valuing companies. Ben Graham taught me a way to value a certain type of business, but the selection of available companies dried up. Charlie taught me about durable competitive advantage. Not how big circle of competence is, but knowing where the edges are is most important. Think about businesses in your own hometown. Ask questions about the businesses. Which do you want to buy into? Which are hard to compete with? Talk about businesses with people. What is working? What is not? You have to ask. You would be surprised at how many companies I know nothing about. The goal is to find companies that will be around for 20 years and offer a margin of safety. You have to recognize your limitations to be successful in this business. Six, seven years ago I looked at Korean stocks, and I could see a number of businesses that met margin of safety. I bought 20 and diversified.
Munger: Obviously if you want to get good at something which is competitive, you have to think about it and practice a lot. You have to keep learning because the world keeps changing and competitors keep learning. You have to go to bed wiser than you got up. As you try to master what you are trying to do – people who do that almost never fail utterly. Very few have ever failed with that approach. You may rise slowly, but you are sure to rise.
Both of the comments are very encouraging to investors. Buffett was more specific in terms of the how to do it, explaining that to be a great investor, you have to have that curiosity that drives you toward asking questions, talking to people and practicing the "scuttlebutt" approach that Philip Fisher detailed in his famous book, "Common Stocks and Uncommon Profits." Also, he provides a very good point talking about investing in what you know well and not superficially. Many times we understand what the company sells; however, this is not the same as how the company makes money. These two, even though they may appear fairly similar, may sometimes vary significantly. And finally, Buffett provides a very important reminder of the importance of applying a margin of safety to purchase price, which is downside protection.
Munger, on the other hand, provided a broader scale piece of advice. His approach is applicable to nearly every endeavor we pursue. Munger talks about that in the competitive world in which we live; thinking and practicing are the keys to rising above the competition. He is famous for being one of the best 30-second minds around because of the multidisciplinary approach he has. Previously, he has mentioned that the key to success is going to bed a little wiser than when we woke up. Just as compounding interest, knowledge accumulates, and it is very likely that we would be in a better position to recognize opportunities as they come along.
Investing is a business that is constantly evolving and changing; however, when we stick to timeless tenets as the one provided by Buffett and Munger, we are very likely to rise in life, as they have mentioned.
What do you think?
