STOCKS ARE PART OF A BUSINESS
“We always look at stocks as being part of a business. I mean, stocks are a small part of a business.”
What does this mean?
When you look at the bigger picture of investing in Warren Buffett’s viewpoint, stocks are like owning part of a house or a car, and is not something you are gambling with.
In the 2020 shareholder meeting, Buffett actually recommended against using margins. This is how he runs Berkshire Hathaway, and also the method in which he invests.
In today’s post, we will be examining quotes from Warren Buffett’s Berkshire Hathaway shareholders meeting in 2020.
We will examine his insight on investments over time with modern day examples for a deeper understanding of how Warren Buffett invests, and how you can invest like him today.
Below is Buffett’s entire excerpt of the 2020 Berkshire Hathaway Shareholder’s meeting. You can watch it if you’d like, or skip over to the blog where I’ve included the entire transcript as well.
WARREN BUFFETT ON RISKS
“If in 1789, you'd saved a small amount of money (and it wasn't easy to save), you might've bought with those savings. You might've bought a tiny, tiny plot of property. Maybe you bought a house that could be rented to somebody, but you didn't really have the chance to buy in with 10 different people who were developing businesses and who were putting presumably their own money. And then that would have the American tail went behind and, and of the 10, a reasonably high percentage would succeed in a way and earn decent returns.
But those are the choices you might've had to do with savings. And they started offering bonds originally. And there again, you've got a limited return, but the return may have been from those days - it may have been 5 or 6% or something of the sort, but you can't buy risk-free bonds. I mean, the yardstick for me is always the US treasury and when somebody offers you quite a bit more than the US treasury, there's usually a reason - others, there's more risk.”
In this excerpt, Warren Buffett discusses risk, which is exceptionally important unless you are investing in treasury bonds that give you a return of around 1-1.5%.
Otherwise, you would have to learn how to evaluate risk and how to reduce it. There are many ways to do this, one simple method is to be very comfortable and aware of the company you are investing in.
This is the reason Warren Buffett suggests that people invest in what they know instead of trying to follow the hype and invest in companies that they may not necessarily know well.
For example, this may happen to a biotech company that has 0 revenue making losses for multiple years, but one day the stock price might jump up fairly quickly if there is suddenly a piece of good news or some sort of speculate.
FLEETING STOCK QUOTAS
“Regarding stocks, people bring the attitude to them too often that because they are liquid and quoted minute by minute, that it’s important that you develop an opinion on them. Minute by minute. Now that’s really foolish when you think about it.”
This is a noteworthy insight because when you’re looking at other markets in the world, you don’t usually get a quote on your assets minute by minute.
If you buy a home, you get a quote maybe once every couple of years or when you sell it. You wouldn’t look at the market every day to see if it is a good time to sell or buy. Because stock has the advantage of being quoted every minute, it actually works against a lot of people.
A lot of times, people want to look at the market every single minute of the day and they spend way too much time when it comes to investing because they want to check their investments and see how they are doing.
This is the exact opposite of what Warren Buffett suggests, which is to be patient and not look at the market every single day, especially if you have a full-time job.
CHARTS ARE A TREND
“And that’s something Graham taught me in 1949. I mean, the single thought that stocks were parts of businesses and not just little things that moved around on charts because charts were very popular in those days, whatever it may be.”
Here he mentions charts, which is technical analysis - the study of price and pattern. It was popular back in the 1980s or what not, and is still fairly popular nowadays.
Usually people who use technical analysis are short-term or day-traders where fundamental analysis doesn’t come into play.
This is interesting to me that he mentions that it was popular back then, because they are still popular today and likely will be in the future as well, especially now during this pandemic where everyone is trying to be a full-time trader to make a living.
COUNTED CASH-FLOW METHOD
“Imagine for a moment that you decided to invest money now, and you bought a farm - let's say you bought 160 acres and you bought it at X per share or per acre. And the farmer next to you had 160 identical acres, same contour, soil quality, identical. And that farmer next door to you, was a very peculiar character because every day that farmer, with the identical farm said “I’ll sell you my farm or I'll buy your farm at a certain price,” which he would name. That's a very obliging neighbor. I mean, that's gotta be a plus to have a fellow like that, but the next farm, - you don't get that with farms. You get it with stocks, you want to own a hundred shares of general motors. On Monday morning, somebody will buy your a hundred shares or sell you another a hundred shares at exactly the same price. And that goes on five days a week. Imagine if you had a farmer doing that, when you bought the farm, you look to what the farm would produce. That was what went through your mind, either saying to yourself on paying X dollars per acre. I think I've got so many bushels of corn or soybeans on average some years, good, some years bad, some years the price will be good. Some years the price will be bad, et cetera.”
This is what Buffett describes here is the counted cash flow method, in which you think about how much this farm will produce when you purchase it and how much money it will make, then work backwards to determine how much the farm is worth.
Then you will want to project that number over the next 5 to 10 years by looking ahead and thinking about how much these 160 acres can produce.
When you are looking at the stock market there is a quote for Apple, Tesla, and other stocks, but that does not represent what the prices used to be.
This is really what the goal of fundamental analysis is, to calculate intrinsic value of businesses years in advance. If Buffett is buying something today, he is not planning to sell the stock tomorrow. He is planning to sell the stock 5 or 10 years from now.
INVESTING IN A VOLATILE MARKET
“But you think about the potential of the farm. And now you've got this idiot that, uh, buys a farm next to you. And, and on top of that, he's sort of a manic depressive and drinks, maybe smokes a little pot. So his numbers just go all over the place.”
I find it kind of humorous that he mentions that the other farmer, your neighbour, is smoking a little pot and his numbers are all over the place.
That is actually a great way to understand the market because the market will always be quoting you prices all over the place.
When you look at the S & P 500, the volatility on a monthly basis can be plus or minus 20%. This means that the S & P 500 is a very volatile market so when you are looking to invest in such a market, do make sure that you are confident in your investments.
This is so that if the day comes that the market suddenly quotes you a low price, you do not panic and start selling. This is actually a common mistake that I’ve seen many people make in March during the COVID crash.
In fact, if they had held off and not sold their investments, they would have been fine by now, 9 months later.
When it comes to this farmer next door, you have to remember that they are there to serve you and not to instruct you. You bought the farm because you believe that the farm has potential to earn and you do not need a quote on it. This is a significant point.
The reason that you may not need a quote is because if you invest in something with a strong rising trend, you can prospect the following multiple years and not have to worry about constantly checking daily quotes.
There are many methods for understanding trends.
Many people will advise you to “Invest in trends” but what does that really mean?
This means that you are invested in a business that is growing, its financials are good, you do your homework and get in at a discount, and your investments will be fairly projected. This is what he is really trying to get at.
ADVANTAGES OF THE STOCK MARKET
“Now if you bought in with John D Rockefeller, Andrew Carnegie, - there were never any quotes but there were quotes later on, but basically you bought into the business and that's what you're doing when you buy stocks. But you get this added advantage that you do have this neighbor who you're not obliged to listen to at all, who is going to give you a price every day. And he's going to have his ups and downs, and maybe he'll name a selling price, that he’ll buy out, in which case you sell if you wanted to, or maybe he'll name them a very low price, and you'll buy his farm from him. But you don't have to.”
The significant part of this is that the seller next to you is naming a price every single day. You can actually take advantage of that face because you don’t get that with real estate.
You do not have that option for private investments and private companies. So the beauty of the stock market is that you have the ability to know exactly what someone else is willing to pay for it.
If someone is selling you this great company at a low price, for example, during the market crash, then you should focus on buying great companies at a low price instead of panicking and selling.
Just because there is a market crash and people around you are panicking about it, does not necessarily mean that the underlying business has gone bad.
This actually gives you an amazing opportunity to get into a lot of stocks at a discount.
INVEST IN BUSINESSES YOU TRUST
“You don't want to put yourself in a position where you have to sell stocks. You’ll have this enormous inherent advantage of people, yelling out prices all the time to you. And many people turn that into a disadvantage. And of course, many people could profit in one way or another from telling you that they can predict what this farmer is going to yell out tomorrow or your nearby neighboring farmers are going to yell tomorrow or next week or next month. There's huge money in it. So people tell you that it's important and they know that you should pay a lot of attention to their thoughts about what price changes should be. Or you tell yourself that there should be this great difference. But the truth is if you owned the businesses you liked prior to the virus arriving, it changes prices, but nobody's forcing you to sell.”
A few noteworthy points are mentioned here.
One thing is that nobody forces you to sell. Second, you own the businesses that you like.
When investing before, during, and after the pandemic, I only focused on investing in businesses that I like, for example, FedEx, Ulta Beauty, 3M, and American Express.
These are all great companies that I know are safe, and I know their business model, how they work, and I know I can make a decent return from them.
If you focus on investing in companies that you like, know, and trust, then you will have a lot more confidence investing in them.
This is a key difference between investing in an index fund or mutual fund in which you are diversified, but are not particularly familiar with the companies within it versus investing in a company that you know very well such as Apple, Google, Intel, AMD, and Facebook.
With familiar companies, you are more likely to get in at a discount and have more confidence to hold onto your investments longer, because your perspective on investments should not be to predict how it will be tomorrow, but rather that you are the owner of the business.
Although you may only own 0.001%, you are still an owner. This is the way you want to think about the potential of the business you are holding onto.
INVEST IN INDEX FUNDS AND NOT BY PICKING STOCKS
“And if you really liked the business and you like the management you're in with, and the business hasn't fundamentally changed, and I'll get to that little one, a report on Berkshire, which I will soon I promise, the stocks have an enormous advantage. And you still couldn't bet on America, but you can't that unless you're willing and have an outlook, uh, to independently decide that you want to own a cross section of America, because I don't think most people are in a position to pick single stock.”
Buffett says here that you would rather own a cross-section of America rather than picking single stocks.
I put some thought into this idea for quite a while because personally, I pick stocks that I invest in. This is where Buffett’s strategy and my own deviates a little.
He states that most people are not qualified to pick stocks because he understands the amount of research one has to do in order to invest confidently.
You need to know your technical fundamentals, be able to look at different ratios, and you need to look at business models, products, news, and management to name a few.
When you think about that, he doesn’t expect the average joe for example, a doctor or an engineer with no financial background, to perform such a task.
This is why his recommendation for most people is simply to invest in an index swap, which is what he’s famous for.
You can still get an 8 to 10% return over a long period of time.
Personally, if you look at Warren Buffett’s portfolio, you know that he does pick stocks and invests a lot in Coca-Cola and Burger King. He picks specific companies that he likes and invests in them.
That is really the difference, where you’re investing only in the ETF and mutual funds and getting 8 to 10%, versus investing like Buffett in which you invest in a handful of companies and aim for a 20 to 30% return.
If you are happy with an 8 to 10% return, then index funds are the way to go for sure with a low management fee and no headaches. However, if you want to make a high return like Buffett, then you want to consider picking stocks but you would have to be able to do the research and invest in those with good financials that you are familiar with.
“Uh, a few maybe, but, but on balance, I think people are much better off buying across section America and just forgetting about it. If you'd done that, if I had done that when I got out of college, that's all I had to do to make a hundred per one. And I caught dividends on top of it, which would increase substantially over time. Businesses are going to have interruptions and you're not going to foresee the interruptions. And you don't want to get yourself in a position where those interruptions can affect you either because you're leveraged or because you're psychologically unable to handle looking at a bunch of numbers. If you really had a farm, uh, and you had this neighbor and on Monday he offered you $2,000 an acre, and the next day he offers you a $1,200 an acre. And maybe the day after that, he offers you $800 an acre. Are you really going to feel that at $2,000 an acre, when you had evaluated what the farm would produce, are you going to let this guy drive you into thinking I better sell because his number keeps coming in lower all the time.”
To conclude, this was one small part of Warren Buffett's investing strategy.
If you want to learn more about investing and how to use fundamental analysis, technical analysis, and how to become more confident in investing in the market by selecting companies that you like and trust and earn a higher return such as 30%, then you’ll want to attend the free training in the link below.
This will lead you to a free case-study on how to get 30% a year from the market. I’ve also included the link to a free webinar that will educate you on how to use technical analysis and find stocks that are on a discount.