Buffett’s Timeless Advice To Stock Investors

July 31, 2007 by Joe Ponzio

In his 1996 Letter To Shareholders of Berkshire Hathaway, Warren Buffett offered investors some pretty rational advice. I’ll take you through it, but let’s paraphrase his first words of caution: If you aren’t going to own individual stocks, buy index funds-not Wall Street’s mutual funds. Considering that most of Wall Street’s mutual fund managers lose to the markets in the long-term, and if you don’t want to own individual stocks, that’s pretty sage advice from the Sage Of Omaha.

Intelligent Investing Isn’t That Hard

Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses.

You don’t need to forecast the direction of the markets or stare at tickers and quotes all day. Investing is both an art and a science. The science is the easy part-to know what a business can do, you must know what it’s done. The art is predicting with a degree of certainty whether or not it will continue to be business as usual for the next five, ten, twenty, or more years.

Stick With What You Know

Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

Just because you can buy whatever stock you want, doesn’t mean you should. Use the word “no” to your advantage…and your profit. It’s much better to earn 5% interest in cash, than to lose 10% not knowing what you are doing.

Ignorance Is Bliss

To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these.

It takes very little to change a stock price; to change a company requires a colossal effort. If you buy stock because the business is wonderful, hold it until it ceases to be wonderful. Stock market pricing methods have no bearing on the daily or annual operation of a wonderful business. You can ignore them and let your business grow. Don’t worry, the stock price will follow eventually.

There Will Always Be Opportunity

That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses-How to Value a Business, and How to Think About Market Prices.

Every year, tens of thousands of finance, business, accounting, and MBA students hit Wall Street, armed with the “knowledge” of the inner workings of stock prices, the markets, and portfolio theory. So long as these students control the majority of the money, they will control the markets…and you will be able to find opportunities to profit from their short-sightedness1.

Look For Virtual Guarantees

Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.

Invest in businesses because they have been wonderful and because you believe they will continue to be wonderful. Don’t speculate in companies that might be wonderful if this happens and if something else doesn’t happen. Look for a moat-a massive wall that competitors will have to climb to hurt your business. The bigger, the better.

When The Odds Are In Your Favor, Bet Big

Over time, you will find only a few companies that meet these standards-so when you see one that qualifies, you should buy a meaningful amount of stock.

What good comes from owning 50 stocks if only 10 of them are wonderful? Be patient, wait for an opportunity, and then buy enough stock to reward yourself. Diversification is roughly the inverse of confidence. The more confidence you have in a business and the larger your margin of safety, the more money you will want to commit.

A Rule Of Thumb

You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.

Investing is boring. Don’t look for short-term gains or exciting rides. Buy a business with the hopes of holding it forever. Then, sell only when it ceases to be wonderful. Your business will not change substantially in a matter of a few days, months, or quarters. If you are worried that it will, you shouldn’t own it in the first place.

Price Follows Value, And So Too Shall Your Portfolio

Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.

The value of a business does not change on a daily basis, so you should not judge your portfolio’s success with a short ruler. As your businesses grow in value, their stock prices will follow. As their prices rise, your portfolio will rise. It has been that way; it is that way; it shall remain that way.

Note To Business Students

  1. I certainly do not mean to insult the study of business, finance, accounting, etc. However, Buffett and I tend to agree that there are certain courses, lessons, and philosophies that are taught in acedemic programs that simply are not true or useful. As these students graduate and move on to Wall Street, they will often employ programs and methods learned in their studies-programs and methods on which our investment success relies heavily. I consider our views to be fair if for no other reason than that the programs you learn are taught so that you may profit from us.

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