I’ve Been Studying Warren Buffett for 40 Years: 5 of His Best Investing Lessons

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Warren Buffett recently announced that he would be retiring from his role as CEO of Berkshire Hathaway at the end of this year after 60 years of leading the company. Known as the “Oracle of Omaha,” Buffett is one of the best investors of all time and has implemented some tried-and-true strategies that helped him build his wealth.

Robert G. Hagstrom has followed, studied and written about Warren Buffett since 1984, authoring two books about the investment great — “The Warren Buffett Way” and “Warren Buffett: Inside the Ultimate Money Mind.” Hagstrom is also the chief investment officer at EquityCompass Investment Management.

GOBankingRates recently spoke with Hagstrom about the investment principles he learned from Buffett that he believes every investor should apply.

Investing Is Easier Than You Think but Harder Than It Looks

The easy part is investing in great companies. The hard part is holding onto them during market volatility.

A great company is one that generates a lot of cash and can do so over a long period of time, thereby reinvesting it back into the company — which makes the company even greater. [These are] companies that appear exceptional. They appear to have products or services that are in high demand, and they seem to have a lot of sales growth and things of that nature.

The reason you want to hold them and compound them is that it’s easier than having to trade them all the time. When you sell, you now have another decision — you’ve got to go find another great company. But if it’s a great company and it’s compounding at a high rate of return over time, you don’t have to.

In my opinion, it’s all this trading back and forth that trips up most investors. It only takes a couple of bad decisions in trading to blow up your portfolio.

Facts and Reasoning Are More Important Than Stock Market Performance

Remember with your investments, you are neither right nor wrong because the stock market agrees or disagrees with you. You’re right if the facts and reasoning are right.

The market goes up and down in price for a lot of reasons that often don’t have anything to do with the economic returns of your great business. Tariffs, inflation, interest rates, politics — all the headlines that you read, traders around the world are reading the same headlines and they’re trading. They’re trying to trade and profit from short-term perceived changes in prices. That’s a very difficult thing to do and not many people are successful at it.

Prices are going up and down for reasons other than the economic returns of your business, so you’re neither right nor wrong if the prices are going up and down. You’re right if your facts and reasoning are right.

The facts are the reports from your company. What was the sales growth quarter to quarter? What was the earnings growth quarter to quarter? You’re looking at your sales and earnings just as if you owned the entire business yourself and there was no stock price.

People need to look at what their sales and earnings are doing. If that’s proceeding in a good way and it’s marching upward, you have a good investment, no matter what the stock market is doing day to day.

Never Forget That the Stock Market Is Manic-Depressive

Quoting his mentor Benjamin Graham, Warren Buffett reminds us that if Mr. Market shows up in a foolish mood, you are free to ignore him or take advantage of him, but it will be disastrous if you fall under his influence.

If you believe the stock market knows more than you do, the jig is up. You have to be able to look at stock prices and know when the stock market’s making dumb decisions. But you only know that when you know your business’ sales and earnings. If you don’t know the sales and earnings of a company, then you [think] if the price is going up, that means it’s a good company or if the price is going down, that means it’s a bad company.

If you default to the market, you say, ‘Well, if it’s going up, I must buy it. If it’s going down, I must sell it.’ And that’s a horrible way to invest because there are things that are going up that shouldn’t be going up and there are things that are going down that shouldn’t be going down.

There Is a Difference Between Short-Term Quotational Loss and Permanent Capital Loss

Let’s say we bought 100 shares of Amazon at $100 a share. With the volatility in the market, sometimes that price can go to $80 and $90; sometimes it can go to $110 and $120. But it’s when it goes from $100 to $90 to $80 that people get really nervous. They think they have a loss, but all they have is just a quotational loss. It’s a price loss, but it’s not a permanent loss until you sell it.

Now the thing you need to think about in your mind is, is Amazon going out of business? Is Amazon a permanent loss? You must ask, is this a permanent loss for me or is it temporary?

Quotational loss is the difference between temporary price losses. And permanent capital loss is the business is going out of business. People have a tendency to judge just price. They see the price is going down. They think something bad is happening and their company’s going out of business. But sometimes it’s just short-term quotational loss, which has nothing to do with the business.

If you believe in your company, you see the sales are growing, you see the earnings are growing, and the price is going down, it’s actually more attractive to you at a lower price if you wanted to add [more to your portfolio].

Don’t Listen To Stock Market Forecasts

Warren Buffett has long believed that the only value of stock market forecasters is to make fortune tellers look good. The facts are there is no one who can predict [stock market performance].

Markets are complex adaptive systems with millions and millions of people reacting each and every day and changing their opinions and their habits and their behaviors. There’s no computer that could ever forecast how people are going to behave next week — it can’t be done.

We don’t need a market forecaster, no matter how psychologically insecure we are. All we need is to look at what the economic returns are of our business.

Warren Buffett doesn’t forecast the market. He doesn’t forecast the economy. He believes no one can. He doesn’t worry about short-term stock prices because he knows they go up and down for a lot of reasons that have nothing to do with the economics of the business. So he says, ‘We just let our private businesses and our common stocks report to us their economics. Once I see what they earn, I make the decision whether I want to own them or sell.’ And typically he continues to own them because they’re compounding and they generate cash and they put the cash back in the company and it just compounds over time. And that’s been the secret of Warren Buffett.

Source

• Robert G. Hagstrom, “The Warren Buffett Way, 30th Anniversary Edition”

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