Lessons Learned From Warren Buffett

Includes: BRK.A, BRK.B
by: Dan Braem

Since it is that time of the year when many Berkshire (NYSE:BRK.A) (NYSE:BRK.B) shareholders travel to Omaha to attend the annual Berkshire Hathaway annual meeting, I thought I would focus on some lessons that Mr. Buffett has taught the investment community. First and foremost, Buffett is known for his long-term investment strategies. While he is much more than a buy and hold investor, it is his long-term focus that receives most of the praise. For purposes of this article, I will focus on Buffett’s long-term strategies.

Buffett has always said that he looks for:

  1. Businesses that he understands
  2. with good business models
  3. that have predictable earnings and
  4. can be bought at a reasonable price.

I will attempt to apply these criteria to today’s market.

First, Buffett looks for businesses he can understand. Personally, I don’t think Warren Buffett is the best investor of all-time, but I will acknowledge that he is the best businessperson of all-time. Therefore, while he preaches the importance of finding simple businesses, don’t be fooled. Buffett understands several businesses better than most (i.e. insurance). Therefore, each investor will have to determine what they understand and what they don’t. This simple methodology of understanding what you are buying is often overlooked by most investors. However, it is extremely important in the investment decision process.

A second important step for Buffett’s long-term investment strategy is to find good business models. Please keep in mind, this can change over time. As an example, Warren Buffett historically loved the newspaper business because more often than not, newspaper companies had local monopolies (only one major newspaper in a given region). However, we all know that the internet has radically changed this model. In my opinion, here are companies with good business models:

  • Coke (NYSE:KO), Pepsi (NYSE:PEP) and Proctor & Gamble (NYSE:PG) – great brand names, international exposure
  • Google (NASDAQ:GOOG) – huge margins, dominant player in US market, cash flow machine
  • General Electric (NYSE:GE) – industrial juggernaut, #1 or #2 in most of their businesses, AAA credit rating
  • AIG (NYSE:AIG) – top insurance company, tremendous earnings capability

The third step is to find businesses with predictable earnings. For almost all companies, there are always challenges to the business. High commodity cost, economic business cycles, increased competition – all these can impact a company’s earnings. Of the companies I mentioned about, I would consider the first three to be the most predictable, and GOOG (hard to determine when growth will slow) and AIG/GE (issues in finance operations) to be the least predictable.

Finally, Buffett likes to buy companies at a reasonable price. In hindsight, he often likes to find bargains. Examples include GEICO and American Express (NYSE:AXP). However, I believe that he targets companies here he feels comfortable that he will be able to generate a targeted return (probably somewhere near 15% - for arguments sake). Going back to the companies I listed above, Coke, Pepsi and P&G seem far from cheap. Great companies, but personally I think they may be a bit expensive. Google is tougher to judge – the company is on fire and completely dominant in the paid search market. However, if you went through Warren’s first three steps above (identifying a great business), why would you buy Google now (around $600) when the price was $450 several weeks ago?

In my opinion, GE and AIG look the most interesting. I wouldn’t touch AIG at today’s price, $49, but I think it is very intriguing in the $40 - $45 range. GE reported EPS that was lower than the street expected, and the stock took a hit. I am a buyer in the $30 - $33 range.

More important than the companies listed above, I think it is important to go through the exercise of applying Warren’s criteria to an investor’s own individual stock purchases. The approach may not always be the most exciting, but sometimes slow and steady can win the race.

Disclosure: Author is long KO, PEP, PG, GOOG, GE, AIG