Wouldn’t it be great to invest like Warren Buffett?
There have been countless books written about how to do that. Buffett himself has talked a lot about his investing over the years. And he’s shared a lot in his (free!) letters to Berkshire shareholders that live online.
A lot of it is speculative. Some of it assumes that Buffett does things that I’m pretty sure he doesn’t. Some of it is just plain wrong or misleading. And what comes from Buffett himself can often sound as much like a Zen koan as practical investing advice.
But one of the shortest chapters in Andrew Kilpatrick’s huge tribute to Buffett – Of Permanent Value – may capture a secret about Buffett’s investing that isn’t often talked about.
“How to know what Buffett will buy”
That’s the title of the chapter. It’s the kind of chapter-heading that would reel in any Buffett fanatic.
Here’s how Kilpatrick kicks off this single-page chapter:
“No one can predict what Buffett will buy next, but now there’s an easy formula that overcomes the problem. Just buy whatever he liked in his youth whether it’s gum or Cokes. One of his endeavors was selling gum and today Berkshire has billions invested in Wrigley.”
The Wrigley investment has been redeemed (at a large profit for Berkshire!) by the Mars company since the book was written.
Kilpatrick goes on to talk about experiences Buffett had with Coca-Cola, Goldman Sachs (NYSE:GS), GEICO and The Washington Post. All companies that Berkshire either currently invests in, has had an investment in the past or owns fully.
How should we use this?
I think the author offers this “easy formula” mostly tongue-in-cheek.
And certainly I wouldn’t advise you to take the investment strategy of investigating Buffett’s childhood and trying to invest in the companies he was exposed to in hopes that he’ll soon make an investment through Berkshire!
But I think what Kilpatrick correctly identifies here is a simple truth of Buffett’s investing: He invests in businesses he knows and understand really well.
This is critical, because, as we often talk about here, investing well depends on being able to see when the value of a business is higher than what the stock market values that business. Knowing how the market values the business is easy – that’s readily evident through the stock price. But making a good estimate of what the business is actually worth requires that you know that business – or at a minimum, that industry – very well.
The “Buffett shortcut” and you
Taking this further, what you should completely ignore is the idea that you should invest in the types of businesses that Buffett invests in. Maybe you should. But only if you have long experience with those types of businesses and industries.
However, if your experience is with biotech companies and you know nothing about banking (an industry that Buffett loves), you’d be nuts to try investing in banks rather than biotech companies. If you’ve been employed in the semiconductor industry for 20 years, it’d be likewise silly to eschew investing in chip companies just because “Buffett doesn’t like tech.”
Expanding your possibilities
This approach naturally limits the breadth of companies that you’ll be investing in. And that’s not a bad thing – Buffett himself has always talked about respecting your “circle of competence.”
And it doesn’t mean that the industries and companies that you know today are all that you’ll ever be able to invest in. If you find another area interesting, you can spend time learning about that to gain the understanding necessary to invest in those companies.
Taylor Muckerman,
Motley Fool Canada
The Motley Fool owns shares of Berkshire Hathaway (NYSE:BRKa).