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Invest the Warren Buffett way

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by Peter Switzer

There are many important jobs investors should do to make sure they’re not making mistakes but high priority should be understanding how Warren Buffett approaches investing.

In his 2010 letter, which is a long one, running 105 pages, he outlines 10 points that lie behind a lot of his thinking and investing.

The AFR’s Barrie Dunstan recently listed them and so this is my version.

Ten points

1. You don’t have to focus on year-to-year numbers because some companies need time to bring the returns to the table. A company such as QBE could easily be dumped with the US dollar low and the Oz dollar so high but time could be on its side, eventually.

2. There’s correlation between earnings and share prices. Even though they can get out of sync, eventually share prices will match up well with profits. That’s why I expect our share prices eventually to catch up with profits. By the way, they can happen in reverse but I don’t think it will apply over 2011.

3. Judging the value of a share rests on what the company will do in the future, not what they are doing now. Virgin Blue is planning on taking on the business travel market and if it works it should help its share price in the future.

4. Always be on the lookout for a company with opportunities ahead and be ready to pounce.

5. Keep a large reserve of cash or at least a line of credit to pounce when an opportunity arises. After Lehman Brothers failed, Buffett loaned Goldman Sachs billions through a bond deal at 10 per cent — having money and guts made Buffett a lot of money.

6. Never underplay the importance of liquidity. This is something ABC Learning’s Eddy Groves needed to learn before he went on his buying spree in the US and UK.

7. Companies should look at buying businesses against what is available on the stock market. These are good measuring sticks to work out value of respective investments.

8. Be careful of borrowing to make money out of investments. Buffett knows you can do well but he says it is “addictive” and it often ends in tears. Clearly, you have to make sure you can endure a big fall in the market and you have to borrow within your means.

9. Buffett talks about the importance of great managers and how he hires well and it means he needs to do less managing. But for an investor, strong management is an important box to tick.

10. The Oracle of Omaha likes companies that pay dividends and have a history of increasing their dividends.

Intrinsic value

Buffett is a guy who places a lot of faith in working out the intrinsic value of a company and when this is less than the market price, that’s when you should buy. It’s not anything new. After all, we all try that when we’re buying a house which needs some renovations or a bit of vision. The same attitude needs to be taken to investing but, of course, the work has to be put in to understand the intrinsic value of a company.

That is the most important job of any investor and over the next few weeks I will look at how you can get good at that.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Watch more from Peter on SWITZER TV.

Published on: Thursday, March 10, 2011

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