Name: The Warren Buffett Way
Rating: 4.4 (20 reviews)
Author: Robert G. Hagstrom

What’s in it for me? Learn about the greatest investor in the world.

Many people think of Warren Buffett as a statistical anomaly, so you might be surprised to find out what he attributes his success to. It isn’t intelligence or an advantageous start. It isn’t a supernatural insight into the market. Distilled into the simplest terms, it’s just following sound business practices and putting in the time – both of which can be taught.

In this Blink, we’ll get into Buffett’s background and the early lessons that set him on the path to investment success. Then we’ll discuss the influential figures and decisions in his life. After that, we’ll outline his basic business tenets, the psychology of finance, and the importance of rational thinking.

A promising start

When he was eleven years old, Warren Buffett made his first investment. He’d saved $120 from entrepreneurial endeavors like selling soda and peanuts. So he studied the price charts and confidently made his purchase. But as it often happens, the stocks dipped, immediately losing value. When they rose again to slightly above what he paid, Buffett panicked and sold at a profit of $5. Shortly after that, the stock value skyrocketed.

He’d learned two tough lessons: He would never again obsess over what he paid for a stock. And he would never sell for anything less than a substantial profit.

After that, everything Warren Buffett touched seemed to turn to gold. Not that he didn’t work for it – he graduated college and then fought for a position at Graham-Newman Corporation, where he got his real education in trading. Then, at the age of 25, he started his first limited liability partnership with a $100 investment and the simple goal of beating the Dow Jones by 10 percent a year. He ended up beating it by 22 percent – and, over a 12 year period, grew his investment to $25 million.

In 1965, four years before ending the partnership, Buffett bought Berkshire Hathaway, which had begun in 1889 as a cotton manufacturer. As the textile part of the business was slowly dying, Buffett made a decision that would shape the rest of his life. In 1967, he bought up the outstanding stock in two decently healthy firms: National Indemnity Company and National Fire & Marine Insurance Company. It was a dramatic departure from textiles – and it took Berkshire Hathaway from $2.9 million in securities to $5.4 million in just two years. This decision set the company on course to becoming the investing giant it is today.

From his first limited liability investment of $100, Warren Buffett is now worth over $100 billion. Many people consider him to be a systemic anomaly. There’s a long-accepted school of thought in the investor world called the Efficient Market Hypothesis that says you can’t beat the market. And Buffett himself expresses that he won a genetic lottery, having the right skills in the right moment in time to flourish.

That said, the rest of this Blink will explore Buffett’s ability to beat the market not with chance, but with skill.

A good education

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.

The Buffett buying guide

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.

Meet Mr. Market

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.

Patience and rationality

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?

Key ideas in The Warren Buffett Way