About the Author:
Robert G. Hagstrom is Senior Vice President and Director of Legg Mason Focus Capital. He has authored the New York Times best-selling The Warren Buffett Way and The Warren Buffett Portfolio, as well as The Nascar Way. The book takes about the principles that laid foundation and influenced Warren buffet in his decision-making skills. He is successful investor of all times and there no one even today’s generation to match of his skills.
His beginning Days…
Warren Edward Buffet was born in Omaha and was seventh generation of Buffets to call Omaha their home. Since his childhood he was always fascinated by numbers and was calculating machine even before he entered kindergarten. At the age of 10 he was introduced to son of Sidney Weinberg who was a senior partner in Goldman Sachs. Warren buffet was intrigued with the stock market at very young age. He would often visit his father’s brokerage firm and visit Harris Upham brokerage in New York twice a week. He was interested in learning about securities, bonds and stocks. He brought his first shares of stock at the age of 11. He later enrolled himself in University of Pennsylvania’s Wharton school of business and finance. After graduation he got back to stock market and started detailed research. He got connected to brokers and subscribed to various publishing services. He took classes on investment and stock market by Graham which was class of 20. Buffet was brightest among the students and there was amazing chemistry between Benjamin Graham and him. After graduation he returned to Omaha and joined his father’s brokerage firm, recommending stocks based upon the Graham’s approach. Later he got job in Graham-Newman and worked for 2 years until the firm broke off
Early Business…
The Buffet Partnership was started with totally 7 partners and total contribution of 105000$.The deal was the partners got 6% per year on their investment and 75% of the profits made above this and buffet received remaining 25% of the company’s profit. Initially the company brought undervalued stocks based on the Graham’s stock criteria. They initially brought stocks of 2 merging companies and sold to create risk less profit. As years progressed the company made good growth, thus attracting more investors to company. Initially the firm confined to buying undervalued securities and merger arbitrage. By the end of 5th year, he purchased Dempster Mill Manufacturing company which was a farm equipment company. Despite shift in the market psychology and change inflection point Buffet Partnership was showing outstanding results. But with the change in market psychology, the market was highly speculative, and stock were highly priced. In 1889 Berkshire Cotton Company was started and as it progressed, they combined operations of other mills. In the year 1995 buffet merged Hathway manufacturing with Berkshire and named it as Berkshire Hathway. Though the textile industry didn’t work out buffet had learnt few lessons in business which had a long-term impact. Enough capital was not generated to buy an insurance company. In March 1967, Berkshire Hathway purchased outstanding stock of 2 insurance companies who has their headquarters in Omaha. They were National Indemnity Company and National fire and Marine Insurance Company. Few additions were GEICO and owned nearly half of its outstanding common shares by the 1991.The amazing qualities of Warren Buffet were being logical, simple and understandable and never complicated the business. Even in the annual report published by the company the data provided are very transparent. The report shows both the sides of the organization risk and uncertainty involved.
Investment Learning Days….
Warren buffet education was influenced by 3 different people who had 3 different distinct philosophies towards investment. They were also very powerful people in this profession. They were Benjamin Graham, Philip Fisher and Charlie Munger. Buffet was influenced deeply by Graham. He initially learned the philosophies of investment through him and worked for his company. Graham always believed in taking logical approach when considering whether to buy a stock or not. He also believed that it is important to buy undervalued stock No matter what market value is, ensuring there is always a good amount margin of safety. He also believed in importance of calculate the future growth of the firm.
Philip Fisher started his career as an investment counselor and a graduate from Stanford graduate school of financial administration. His main philosophy, it important for any investor to first analyze the company and industry thoroughly first. Understanding their operation, how consistent their earning has been, efficiency of the management and the future prospects of the firm. Buffet met Charlie Munger, a lawyer through Dr. Davis when he had returned to Omaha at a local diner. But had great interest in stock market and just intrigued by them. Later he started an investment firm simultaneously practicing law as well. Later Charlie joined on Berkshire board and today he is vice chairman of the firm. Charlie laid business foundation apart from involving in investment decisions with buffet.
Investment Principles:
There were certain set principles or tenets that acted as a guide in this decision-making process and they were grouped in 4 broad categories. They were Business tenets, Management tenets, Financial tenet and Market tenet. There are totally 12 tenets which served as principles based in which Buffet as well his firm Berkshire Hathaway worked. Although all the investments made by him didn’t follow all 12 of them at once. The only exemption that deviated this principle was General Dynamics and Wells & Fargo company(bank). With General Dynamics he initially brought arbitrage stocks in Dutch action. The industry should be easy and understandable and should have efficient management. The investment should be made for longer term to reap better benefits. Warren buffet after brought at better discount rate and ensures that there a good margin of safety. He always buys shares of a company and preferred the stock market to delay the recognition as it gives him occasion to buy more shares at bargain prices. It is also important to analyze the long-term prospects or the prospects of the company. Buffet also said for every penny invested in the market, the return should be at least one dollar.
Learning and Tips:
For me as a learner, I learnt that for a firm which makes excessively good amount of profit it either pays more dividends to its shareholder or buyback /repurchases of shares else they invest in buying or expanding in other business. They buy other companies from business line or other which might not be doing well. This increases the expenses of the firm and reducing the profit that is earned. This leads firm to a very bad position of the firm and it leads to change in management and liquidating the business. Another learning is that Buffet is not interested short term appreciation and is not in a hurry to sell that stocks. He prefers to keep them as long as the firm is functioning well, management is efficient, competent, honest and business is not overvalued. But it is not important that we analyze and buy stocks or owning business, it also important that we manage the portfolio that we invest in. Though decisions to buy stock are taken majorly based on margin to safety approach but there 3 other important constructs for portfolio management which buffet developed. There are 2 types of strategies one being active portfolio management and another index management. Both the strategies offer more diversification, but do not offer exceptional returns on the investment made. But according to buffet there is a third category that is focus investment. This simply means that choose and invest in few stocks that are likely to give above average returns over long period of time, rather than investing in bulk and can sustain the short-term fluctuations. He further talks about how focus strategies have advantage over the convectional diversification. We all know stock market, probability plays a very important role and one plays one of the determining factors of the stock prices. There were lot of theories explaining this concept and they are amazing and can be better understood in reading them.
People who are into the stock markets can divide their strategy into two ways one is prime bet and other action bets. Prime bets are serious bets. Action bets are for longer shots and hunches. Focus investing has been recommended by from the time of Graham. People like Graham, Philip, buffet and few others are known as super-investors and believed strongly in focus investing. Also, they were involved investing in stock market with the long-term returns and invested in business or stocks after details research. But nowadays it’s different what they the investors tell the client and what they follow are completely different. Also, the performance of people who recommend where invest, sell, buy or hold of the stock based on their return they in short term. They analyze their performance for each quarter and hence they do not get the exponential return on the investment but also, they do not get to deep research on the recommendations they give. It is because of their nature of working on short term return, they are not able to achieve what people like Warren buffet, Graham was able to.
Psychology and economics go hand in hand in the investment and use them to look through the issues of finance is today’s world known as behaviour framework. Overconfidence and overreaction bias characteristics of any investor play a very bad role. Today’s investors think they are over-smart, have superior knowledge than other /their colleagues and are not ready to accept their mistakes. The investors usually follow what other people follow or act accordingly to the trend with understanding where they are headed and their impact. This effect is known as the lemming factor. Investors should be psychologically ready even bad effect of the stock market, they should analyze them and rectify the mistakes. Generally according to modern portfolio diversification, in order to reduce the impact of its important diversification and selling the stock off in shorter time. According to buffer risk refers to harm or anything bad. Also holding the investment for a longer period of time can minimize the risk or there can no risk.
Time and patience play a very important role in economics and investing. There are 2 sets of strategies involved in the stock market that short term and long term. The risk involved with the short term is high and return is unpredictable. In long term investment, the return is much higher, and the risk involved is lesser when compared to short term strategies. Also, it is important for an investor to be rational in his decision-making process in the stock market. Rational meaning taking the decision very logical and full knowledge rather than taking decision-based on speculation or what others in the herd/group is following. Thus, in long term investment, it important to consider the time factor and have the perseverance to patience. In the investing field, it not only important to have IQ and talent, but also necessary to have output in proportion. To get the desired output it is required to have a rational decision-making process and do thorough research before deciding where to decide and how much to decide and hence acts as tip of the iceberg.
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