The teachings of Warren Buffett

At the end of last year, Warren Buffett retired as the Chief Executive Officer of Bershire Hathaway after 60 years of service. His record as an investment manager has not been and may never be equaled.

Over 60 years, Berkshire Hathaway’s compounded growth was nearly double that of the S&P 500, with a 19.9% annual return compared to the S&P 500’s 10.4%. This resulted in a vastly greater total return for Berkshire Hathaway stockholders, growing 5,502,284% versus the S&P 500’s 39,054% from 1965 to 2024. This means that $1,000 invested in Bershire Hathaway in 1965 would amount to $55,000,000 in 2024 while the same amount invested in S&P 500 stocks would amount to only $390,000.

Outstanding though this was, we would argue that the greater legacy of Warren Buffet would be as a teacher. A teacher has been defined as a person who believes that imparting knowledge is not a zero-sum game where the gain of the pupil is the loss of the teacher. A teacher sees the imparting of knowledge not only as a gain for the student but also for the teacher, his knowledge not lost but even enhanced and expanded, a win-win situation.

Unlike most investment managers who prefer to keep their winning strategies secret, Buffett has been the most open in sharing his knowledge, in the annual letters he sent to his stockholders, in the answers he gave during the question period at the stockholders meetings, in the speeches he delivered, and in the interviews he gave.

Encouraged by his example, we are sharing the lessons we have learned from the teachings of Warren Buffett.

Buffet’s first lesson is to explain why we should have an investment portfolio:

“If you don’t find a way to make money while you sleep, you will work until you die.”

The idea is that if you are a professional, you will stop earning when you retire. Thus, you must have an investment portfolio so that when your professional income stops, you can then draw on the income from your investment. Thus, you will not suffer a loss in your financial standing.

Moreover, Buffett suggests that when young you can be more aggressive and concentrate in a few stocks in investing your portfolio given that you need to speedily build up your investment. And being young you can still have time to recover from your investment mistakes. However, as you near retirement age, you have to start being conservative and diversify from stocks to bonds such that the sure income from the interest from the bonds will allow you to achieve your desired portfolio size upon retirement. Again, from Buffet, “Diversification may preserve wealth, but concentration builds wealth.”

The next lesson is when to sell your stock. This is based on the principle that one should have an exit strategy when one wages war, sets up a business, or invests in a stock. After all, only when you have exited from these endeavors can you judge if they were successes or failures.

The conventional wisdom is one sells a stock to lock in profits, i.e., sell the stock above acquisition cost; cut losses, i.e., sell the stock below acquisition cost or to exit from a stock which does not move at all.

Buffett argues that this is the wrong approach as the decision is determined by your acquisition cost. And the market does not care at what cost you bought a stock.

Instead, Buffet suggests answering two questions. The first: If I did not own the stock, would I still buy it? This raises the question of whether the conditions which initially led to buying the stock have changed. These could be changes in the industry structure, changes in management, or arrival of strong competition. For example, Buffett divested his investment in the media company, The Washington Post when he realized the rise of the internet posed a risk to the traditional newspaper.

The second question, especially applicable to small portfolios: Is there another stock which has better prospects than the stock I currently own? If so, I would sell the stock I own and use the proceeds to buy the more attractive stock. Technically, this is called rebalancing your portfolio.

We now come to stocks that Buffett is not interested in. He does not want to invest in assets which generate income only when sold, more specifically commodities. For example, when you buy gold, you do not generate income until you sell the gold. Moreover, as you do not physically hold the gold, you have to pay for somebody to have custody of your gold.

Related to this is the “greater fool” theory. I may be a fool to buy this asset but a greater fool will come along and buy it from me at a higher price. The problem with the theory is that you could be the greater fool buying from the lesser fool.

With respect to buying stocks, Buffets follows certain rules.

The first and foremost rule is “never invest in a business you do not understand.” This simply means knowing why or how a business makes money. A simplified approach would say “Coca Cola is a company selling sugared water at a price much higher than the combined price of the water and the sugar.” And then proceed to understand how it does so, i.e., adding a secret ingredient, carbonizing the drink, attractive packaging, and a vast distribution system.

From understanding the business logic, Buffett then examines how the company defends itself from others copying its successful formula. Buffet looks for “economic moats” in companies.

Buffett views a business as an “economic castle.” The value within the castle represents the company’s profits and market share, which are constantly under “siege” from competitors. The moat acts as a protective barrier, making it difficult for rivals to erode the company’s position. A wider, deeper, and more durable moat signifies a stronger business.

Buffett elaborates, “We’re trying to find a business with a wide and long-lasting moat around it, surrounding and protecting a terrific economic castle — with an honest lord in charge of the castle… For one reason or another, it can be because it’s the low-cost producer in some area. It can be because it has a natural franchise or because of its service capabilities, its position in the consumer’s mind, or because of a technological advantage. For any kind of reason at all, it has this moat around it.”

If based on the above, Buffet concludes that it is an excellent company, he then proceeds to determine the value of the stock. As he says, “Price is what you pay; value is what you get.”

There are two basic approaches to determining the value of a company, the Price/Earnings approach and the Discounted Cash Flow approach which we will not discuss here.

Assuming the value of a stock has been determined, then Buffett argues, “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” In short, look for wonderful companies to invest in and be satisfied with buying the stock at a fair price.

Moreover, Buffett times the buying of these stocks. He is a contrarian or, as he says, “Be fearful when others are greedy. Be greedy when others are fearful.” What this means is that while others (the greedy) aggressively buy when the market is at its peak (a bull market), thus depleting their cash reserves, Buffet (the fearful) refrains from buying. Instead, he starts building up his cash position.

With his large cash position, Buffett (now greedy) starts buying his selected stocks when the market goes down (a bear market) while the others (now fearful) start selling. This is difficult to execute but highly rewarding. As Buffett says, “Cash combined with courage in a time of crisis is priceless.”

We end with one final teaching which relates not to investing but in leaving a legacy: “Someone is sitting in the shade today because someone planted a tree a long time ago.”

Warren Buffet could be referring to the hundreds of thousands of stockholders of Berkshire Hathaway who benefitted immensely from their investment in the company. We would argue that it should also refer to the millions of investors who followed the teachings of Warren Buffet and so invested wisely and well.

Dr. Victor S. Limlingan is a retired professor of AIM and is a fellow of the Foundation for Economic Freedom. He is presently chairman of Cristina Research Foundation, a public policy adviser, and Regina Capital Development Corp., a member of the Philippine Stock Exchange.