Investing like Warren Buffett

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Warren Buffett is one of the names all investors know. Born in 1930, Buffett has spent his life in Omaha, Nebraska apart from a brief sojourn to New York to Columbia University, where he studied finance under the legendary Ben Graham. Buffett later worked for Graham for a spell.

Buffett's investment philosophy is strongly influenced by Graham, but not exclusively so.

Graham's value investing approach looks purely at the financial characteristics of a company's balance sheet and ignores the fundamentals of the business. Buffett's approach is essentially one of investing from a business perspective.

He largely eschews Wall Street and invests for the long term, seeking out businesses with outstanding businesses with high returns. He looks in particular for businesses with strong brands and high barriers to entry.

Buffett styles these as "toll bridge" businesses.

He attempts to buy large stakes at bargain prices, taking advantage of periods of illogicality in the market. This can perhaps be best seen in his recent moves. Buffett took stakes in both Goldman Sachs (GS) and General Electric (GE) at times of extreme market weakness and did so on exceptionally favourable terms.

Buffett's methods, and the returns they have produced, have produced tens of thousands of devoted adherents. Many of them follow Buffett with the passion of religious zealots. But Buffett's choice of investment vehicle is at times more sophisticated, and his investment method more subtle than his homespun folksiness might indicate.

He has, for example, invested in hedge funds, in zero coupon bonds, in silver, in currency markets, and most recently in corporate preference shares. He has, however, been scathing about derivatives describing them as financial "weapons of mass destruction", a monicker with which few would now disagree.

Buffett's route to success is the subject of numerous books, so the history is well known. He started running his own investment business in the late 1950s, eventually choosing as his vehicle, Berkshire Hathaway (BRK.A), a near-defunct textile business which he converted into a cash shell. A seminal move was to buy up insurance companies and to use the cash-flow (or "float") that they provide to fund his investment activities.

Berkshire's investing is partly though directly-owned businesses typically still run by their incumbent managers, and large-scale portfolio investments in companies like Coca-Cola (KO), Gillette, The Washington Post (WPO), Wells Fargo (WFC) and a range of others that now include General Electric and Goldman Sachs.

What these businesses have in common is a long history and venerable, widely respected names. These should translate, so the theory goes, into above average returns for shareholders.

Berkshire Hathaway is now of such a size that Buffett faces a problem. It is hard for him to find investment opportunities of a sufficient size to influence Berkshire underlying performance. That's one reason why the current bear market has been something of a boon for Buffett.

Peter says

Buffett exudes good sense, and his record speaks for itself. But undue devotion to his methods is perhaps a mistake.

Buffett's long investment timescale and his shunning of investment income as an end in itself may not fit well with the goals and aspirations of some investors. Retirees who need investment income to live on might not find Buffett's methods entirely helpful.

Buffett is, in short, unique.

Mimicking his methods can be self-defeating. Articulating Buffett's methods can seem trite, certainly relative to the supposed sophisticated approach to finance advanced by Nobel Prize winning financial economists. He says, "all there is to investing is picking good stocks at good times and staying with them as long as they remain good companies."

He was also noteworthy for shunning investment in the bubble and the whole mortgage backed securities, sub-prime lending and credit default swap nonsense. He has explained this aversion to esoteric investments then as now by saying that he would not invest in businesses or financial instruments that he did not understand. "I want to explain my mistakes", said Buffett, "so this means I only do the things I completely understand".

Buffett is also much more self deprecating of his own abilities than most investment bankers and other so-called 'masters of the universe'. "I watch my every move", he says, "and I'm not that impressed".