Over the past seven decades, Warren Buffett (Trades, Portfolio) has developed and refined his investing skills. While he still makes mistakes, I don't think it's unreasonable to say that he's probably the most experienced investor alive today.
So, how would the most experienced investor alive today teach novice investors how to pick and value stocks?
Buffett, the teacher
Buffett himself was taught how to invest by Benjamin Graham. He was allowed to refine his process for a short period when working for Graham as a security analyst after he graduated from Graham's class.
Unfortunately, Graham quit the investment business soon after, leaving Buffett to go it alone. The young investor rose to the challenge, and over the next few decades, he refined his investment strategy, changing with the times and slowly moving away from value towards quality at a reasonable price.
Throughout his career, Buffett has repeatedly stated that business school is not the best way to learn to invest. He believes business school teaches too many unproven theories, such as the efficient market hypothesis, and does not take into account the messiness of real-world investing where companies cannot be distilled down into a simple formula.
Instead, Buffett has advocated a similar approach to the one Graham used to teach his students. Speaking at the 1998 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting of shareholders, Buffett said the way Graham liked to teach was to play "various little games:"
"Sometimes he would have us evaluate company A and company B with a whole bunch of figures, and then we would find out that A and B were the same company at different points in its history, for example."
The goal of this process was to "get us to think about what were the key variables and how could we go off the track." This process is the perfect way to teach investors how to value companies.
"But I would, you know, if I were teaching a course on investments, there would be simply one valuation study after another with the students, trying to identify the key variables in that particular business, and evaluating how predictable they were first, because that is the first step. If something is not very predictable, forget it. You know, you don't have to be right about every company. You have to make a few good decisions in your lifetime. But then when you find — the important thing is to know when you find one where you really do know the key variables — which ones are important — and you do think you've got a fix on them."
No correct answer
Charlie Munger (Trades, Portfolio) added that it is also essential to understand that there is never a right answer in business valuation.
Unlike real estate appraisal, the value of a business will always depend on multiple different factors, some of which you will never know or understand. It is vital to incorporate these in the process, which is one of the reasons why Buffett and other value investors like to include a margin of safety when buying a stock.
Buffett's advice here is helpful, but if you really want to understand more about how Graham taught business valuation, I highly recommend seeking out his Columbia Business School lecture notes.
These notes give readers invaluable insight into how the dean of value investing went about teaching his art. Even though the companies featured are no longer around, the process is still as relevant today as it was when the notes were first put together, nearly six decades ago.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- When Is the Best Time to Sell a Stock?
- Warren Buffett's Advice on Choosing an Index Fund
- Buffett: Bershire Is Worth Much More as One Than Broken Up
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