Most of you have probably read at least a little about master investor Warren Buffett. The long-time CEO of investment conglomerate Berkshire Hathaway (NYSE: BRK-A, BRK-B) is a investor, philanthropist, teacher – and the world's third richest person, according to Forbes magazine.
He has flourished through many economic and stock market cycles – not beating the market every single year, but increasing the book value of Berkshire Hathaway at a compound rate exceeding 20% since 1965, while the S&P 500 (with dividends reinvested) increased by just under 9.5%. If you're wondering what 20.2% annualised gains look like, the total increase in book value between 1965 and 2010 was 490,409%!
An open book
Far from being secretive about his methods, Buffett is giving increasing numbers of media interviews, answers questions from shareholders for hours on end at the Berkshire AGM, and communicates candidly (without spin, and with admirable candour when he gets it wrong) in his letters to shareholders.
He's certainly not perfect – and would be the first to admit as much – but investors can do much, much worse than look to Buffett's record, writings and interviews for a top notch investing education.
Back to the sweet spot
I wrote recently about an atypical – on the surface at least – Buffett purchase, when he took a large stake in technology company IBM (NYSE: IBM). He had previously given the technology sector a very wide berth, simply declaring it outside his circle of competence. It was when he realised IBM shared some similar traits with his more usual investments that Buffett decided to buy.
Buffett's latest purchase – an increased stake in UK-based retailer Tesco (LSE: TSCO) – is more typical of the Oracle of Omaha. It ticks quite a few of the 'usual' Buffett boxes, and it provides an indication of Buffett's longer-term thinking.
Three out of three
Firstly, Tesco, the world's third-largest retailer, is a business Buffett knows well, having held a stake in the company for many years. He's followed its journey and he understands how it makes its money.
Secondly, Tesco is a well-known and trusted brand, particularly in the UK, with an enviable physical network of stores and a 'repeat business' model, selling household staples that shoppers need every week. Think the UK version of Woolworths (ASX: WOW).
Lastly, Tesco shares had fallen 25% between early January and last Monday, after the company warned that the current financial year's profit would be at the lower end of forecasts, and that the following year may see little to no growth in profits as the company reinvests in improving the customer experience (probably lower prices and store refurbishments).
The first two elements are qualitative factors that are common to most Berkshire Hathaway investments – well known, easy to understand businesses with high brand equity and repeat business models.
The third is where Buffett truly excels. By taking a very long term view, Buffett is betting that the short term hiccup will be exactly that – a speed bump that has lead panicked investors to offer him a cheap price for their shares. If he's right that this truly is only a temporary problem, he has been able to top up his shareholding at a bargain basement price.
It's all about the long term
Perhaps surprisingly for those who aren't familiar with Buffett, it would almost have certainly been music to his ears to hear that the company is forgoing profit growth next year to make itself a more attractive destination for its customers. When a company is spending money today to build itself a larger competitive advantage – a bigger moat in Buffett's parlance – which will pay dividends for years to come, Buffett is only too happy to wait for the pay off.
Warren Buffett didn't become the world's richest man by sheer luck, or by placing a large bet on one or two outcomes that happened to go his way. He has a 50-plus year record of consistently outperforming the market – and has seen off many naysayers claiming he was just lucky, had lost his touch or that 'this time it's different'.
If anything characterises his investing, it is making every effort to understand how a business makes its money, what threats face the company and making sure he doesn't pay too much. By being prepared to be patient, Buffett also left himself a war chest of cash to be deployed when the opportunity arose.
Foolish take-away
Buffett's style may not be for everyone, but his method is deceptively simple to understand – the difficulty is in being patient and disciplined enough to execute it well. I believe there are businesses in the market today that possess many of the characteristics that Buffett values – and at very reasonable prices – for those prepared to do the leg work, and then who have the patience to wait for the returns to come.
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Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in Berkshire Hathaway. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
