The Warren Buffett Way summary

In 1921, a grandmother in Los Angeles opened a candy shop in her neighborhood. Her name was Mary See, and See’s Candies became a multigenerational, multimillion dollar company. It survived some of the hardest times for a small business, including the Great Depression and the sugar-rationing that happened during World War II. The company survived because it was just that good. Quality took them the distance. So, when Grandmother See’s heirs were ready to sell in 1971, they did so for $25 million – to Berkshire Hathaway.

To understand the point of this story, we have to go back and talk about the many influences in Warren Buffett’s life. 

So how does Warren Buffett decide what businesses to buy? Over the decades, he has developed twelve tenets – or checkpoints – to determine whether he’s willing to make an investment.

First, there are the three basic business characteristics. Warren Buffett has long been a believer in investing only within the realm of your own knowledge. In other words, he believes you should know the businesses you’re buying. The businesses should be simple and easy to understand, have an operating history that’s consistent, and offer a favorable long-term outlook.

Imagine you own shares in a business with your partner, Mr. Market. Fortunately, your business is economically stable and has a promising future outlook. But that doesn’t matter to Mr. Market, because he’s prone to sudden shifts in temperament. Every day, Mr. Market offers to buy your shares in the company. Some days, he’s in a great mood and sees the future as bright and sunny – on those days, he offers you a high price. Other days, he sees nothing but doom and gloom, so he offers you a low price. The good thing is, he makes the offer every day, no matter how much you reject him; you can’t hurt his feelings. The last thing to know about Mr. Market is that you’re free to ignore him or accept his offer, but you absolutely should not submit to his influence.

This little analogy was created by Ben Graham, who we discussed earlier. It’s designed to illustrate the importance of being psychologically ready for investing. To be free of Mr. Market’s emotional upheavals, a field of study was formed called Behavioral Finance. Students of this field have discovered several psychological traps that cause investors to make bad decisions. Among them are simple concepts like overconfidence, loss aversion, and the lemming effect – which is the tendency to follow the crowd.

A study analyzed the one-year, three-year, and five-year returns for S&P stocks over a 43-year period. The results showed that the proportion of stocks that doubled in one year was only 1.8 percent on average. For the three-year report, it was 15.3 percent. For the five-year report, 29.9 percent had doubled. 

The aim of the study was to answer the question of whether large returns are possible from long-term investments. And the answer is yes. But still, most stock market activity happens in a reactionary state with short-term thinking in mind. Obviously, this isn’t how Warren Buffett operates, and that’s what makes him so special. But why is he different?