On a recent mini-vacation in the Okanagan I had the welcome opportunity to catch up with an old crony of mine, Gord Wiebe. Gord and I are cut from the same cloth; financial nerds whose Saturday afternoon conversation is discussing writing covered put options.
We were discussing the crazy state of the world of finance, and I’m not referring to the European sovereign debt crisis. In fact, we didn’t talk about Europe at all.
Instead we talked about the 25 year-old research analysts doing the number crunching for various mutual fund companies. Sure, these 25-year olds are bright guys, but back when we had the millennium tech bubble these guys were in Grade 8.
We talked about how investors, disappointed with their investment performance, are susceptible to all sorts of lunacy.
We talked about black-box financial instruments that are so opaque that you have no idea how any kind of return on your investment is going to be generated.
We talked about the blind faith with which newbie investors are scooping up the latest fashion; indiscriminately buying exchange-traded funds while trusting that a cheap MER is all it takes for them to reach their financial objectives.
We talked about how exotic exchange-traded funds have become so perverted from the core principals of ETFs as to become unrecognizable.
Gord, being the smart guy that he is, eloquently summed up how to slice through the din of the financial world. He said “Just read Buffett.” And he’s right.
To give some context, both Gord and I are devoted fans and disciples of Warren Buffett, the World’s Greatest Investor. I’ve attended ten Berkshire Hathaway annual meetings, and Gord’s been a bunch of times himself. We even roomed together on one trip to Omaha. Apparently I snored, but I didn’t hear it, so I have to take his word that it happened.
There isn’t much that Buffett says or does that eludes us, and both of us have Buffett’s fundamental principles memorized. And, given that both of us can finish the other’s sentence when it comes to Buffett, Gord summarizes the state of the financial world with “Just read Buffett.” Brilliant!
As Buffett says, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insight, or insider information. What’s required is a sound intellectual framework for making decisions, and the ability to keep emotions from corroding that framework.”
In simple terms, Buffett determines the intrinsic value of an enterprise, and then buys the investment at a discount to its true net worth. He is looking for good businesses at good prices, and he is not willing to compromise on either aspect. From this simple definition several principles arise:
1. Own Great Business
If a business is doing well and is managed by people with integrity, intelligence, and energy, its inherent value will ultimately be reflected in its share price.
2. Build Concentrated Portfolios
Many investors are over-diversified. This leads to a dilution of the quality of investments, with too much capital tied up in poor investments and not enough in the really good ones. He prefers to find a fewer number of great investment ideas and to take meaningful positions rather than resorting to his second or third best ideas.
3. Invest in What You Know
Some investors will make an investment without really understanding why they would want to invest in a business, or even just what it is that they are investing into in the first place. This is a folly. Buffett wants to know a business inside and out. It is knowledge that allows him to avoid risk.
4. Ignore the Stock Marke
Investment decisions should reflect an opinion of the long-term prospects for a business, not the short-term prospects for the stock market. The stock market is a tool that can be used for our advantage, it is not the arbitrator of our well being. As Buffet says, “As far as I am concerned, the stock markets doesn’t exist. It is only there as a reference to see if anyone is offering to do anything foolish.”
5. Employ a Margin of Safety
The key to successful investing is the purchase of shares in good businesses when market prices are at a large discount to underlying business values for any variety of reasons. In other words, he is looking to buy a dollar for fifty cents.
6. Be Patient
Many of history’s great investors have suggested that the key to their success lay not in what they did, but rather in what they did not do. They did not yield to their emotions or to the pressure to follow the crowd. Instead, they focused on the business they owned and watched as their value compounded over time.
Information on Buffett is easy to come by. There are many, many books written about Buffett, and Buffett’s annual letters to Berkshire Hathaway shareholders are available on the Berkshire Hathaway website.
Confused about the crazy state of the world of finance? Easy, peasy, lemon squeezy, as my kids say.
Just read Buffett.
The opinions expressed are those of Brad Brain, CFP, R.F.P. CLU, CH.F.C., FCSI. Brad Brain is a Senior Financial Advisor with Manulife Securities Incorporated, in Fort St John, BC. Manulife Securities Incorporated is a Member of the Canadian Investor Protection Fund. Brad Brain can be reached at email@example.com or www.bradbrainfinancial.com.