words of the sage of omaha

Ten rules from the world's greatest investor
By Nick Louth, MSN Money special correspondent
Last updated February 3 2005

Learn to be a better investor from the master – Warren Buffett.

The Sage of Omaha – also know as Warren Buffett - is regarded as the world’s greatest investor, having turned $100 invested in 1954 into $41 billion by the end of 2004.

He’s pretty good with words too, as these ten sayings of his show.

1. “All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.”

He makes it all sound so simple. Buffett is very choosy about which stocks he chooses to buy and when, and when he buys you can be sure he’s read right through the annual reports of not just it but the reports of each of its competitors.

What he’s looking for above all is companies with an enduring competitive advantage. If they’ve got that, he’s more than happy to hold for decades.

2. “If the business does well, the stock eventually follows.”

Too many investors spend their time worrying about a share price because they think its gyrations tell them something is happening at the company, something they don’t know about.

Buffett’s confidence in the few businesses he chooses to invest in is such that he doesn’t really care about market prices, which is a reflection of what others think of them. It certainly helps that he either buys outright or gets offered a place on the board of a number of companies that he invests in.

3. “Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management and limited exposure to hard times.”

Understanding what you invest in is the core of the Buffett approach. He has never owned a technology stock because he claims not to understand them. He restricts his investments to companies he really understands.

This tends to lead him to fewer holdings than many other professional portfolio managers have, but they are companies he knows intimately.

4. “In a difficult business, no sooner is one problem solved then another surfaces – there is never just one cockroach in the kitchen.”

...so don’t buy an aerosol of insecticide; sell-up and move house! Buffett’s striking analogy is another reinforcement, if anyone needs it, that you sell shares on the first profit warning. Things are usually going to get worse before they get better.

5. “When a management with a reputation for brilliance tackles a business with a reputation for poor fundamentals, it is the reputation of the business that remains intact.”

This isn’t always true, as Buffett would probably concede, but it is true very often. Don’t bet on corporate turnarounds being successful except where the businesses involved are actually pretty sound to begin with.

For every Reed-Elsevier or IBM, where the business was never really bad and the turnaround worked well, there are dozens like Jarvis or Invensys which are never going to return to their former glories.

6. “For some reason people take their cues from price actions rather than from values. Price is what you pay. Value is what you get.”

Warren Buffett must be one of the few investors who would be happy not to see share prices for his investments for weeks at a time.

He cares so little about the market’s valuation that he actually prefers to see prices falling for shares that he intends to continue buying to make them cheaper. Most of the rest of us feel nervous if we don’t get some validating price rises fairly soon after we’ve started buying a particular stock.

7. “I put heavy weight on certainty. It’s not risky to buy securities at a fraction of what they’re worth.”

Most of Buffett’s approach to investing came from Benjamin Graham, often known as “the father of securities analysis”. In the late 1940s Graham pioneered the concept of value investing, where shares are bought only when they are worth less than the sum of their assets.

Specifically, Graham said that shares which traded at 2/3rds of the value of quick assets (those which can be rapidly sold) could be safely bought. On a typical day there aren’t many companies you could buy at that kind of discount, but just occasionally there are times when vast numbers of firms are being given away at these prices. That leads on to the next rule...

See jargonbuster on net asset value

8. “Most people get interested in stocks when everyone else is. The time to get interested is when no-one else is. You can’t buy what is popular and do well.”

Buying shares when no-one is interested in them would have mean’t getting out your chequebook in the depths of the 1930s depression, in 1975 when UK inflation was soaring and there was secondary banking crisis, and in the first three months of 2003 when the war with Iraq was looming.

Not many casual investors even think about shares when the economy is in dire straits or when we are close to war, which is why many of them only get into shares just as everyone else does and the real value is evaporating.

See my article on contrarian investing

9. “In aggregate, people get nothing for their money from professional money managers.”

In the long term money managers fail to beat the markets against which they measure their performance. Very few buck this trend. It isn’t surprising, really, because funds of one form or another dominate the stock market. What is surprising isn’t that fund managers on average perform averagely, because that is true pretty much by definition. What is amazing is the fact that they get away with charging so much for it.

See my article 'Who needs fund managers?'

10. “You go to bed feeling very comfortable about two and a half billion males with hair growing while you sleep. No-one at Gillette has trouble sleeping.”

This isn’t so much a rule as a celebration of the kind of company that Buffett adores. Gillette has one of the most secure market niches of any company, with a brand that is trusted worldwide.

Though the company has had its troubles even during the years when Buffett was a director, it has come good in the end. Procter & Gamble last week offered to buy Gillette for $57 billion, making the combined group the world’s largest consumer goods company. The offered represents an 18% premium to the Gillette share price, and was described as a “dream deal” by Buffett.