Great introduction to Buffett's investment process
In an interview with ‘The Investors Podcast’, author Robert Hagstrom explains how we can learn to invest like Warren Buffett. Hagstrom has written several of the most recognized books on Buffett and has followed him since the 1980s.
In the interview, we get a nice summary of Buffett’s investment philosophy. Hagstom’s point is that Buffett is first and foremost a business owner and spends the vast majority of his time finding and studying the right companies for his portfolio. This is in contrast to many other investors who spend the majority of their time following the market, the overall economy (macro) and daily stock prices. According to Hagstom, US investors on average own their shares in 4 months. The situation is hardly any different here in Denmark.
According to Hagstrom, there are basically three elements to Buffett’s investment philosophy:
1) Co-ownership of excellent companies
Here Buffett has 4 basic principles (“tenets”) that should always be assessed: The company’s business (i.e. understanding products/services, competitive situation, etc.), the company’s finances (i.e. cash flow, debt, Return-On-Capital, etc.), management (i.e. skills, experience, co-ownership, etc.) and valuation (trading the stock for a price below the fundamental value)
2) Portfolio management
Buffett himself has called his approach “focused investing”. Today, many call it “high active share”. In practice, Buffett has the vast majority of his portfolio in 15-20 companies, typically spread across 4-5 industries. In the past, he has held up to 30% in a single company and his time horizon is typically 10+ years. For Buffett, divesification is a spectrum. For investors with no interest or ability to analyze and value companies, very broad diversification is the way to go – i.e. index funds. For other investors who possess these characteristics, a few (10-20) good companies in the portfolio would be appropriate and could provide a higher return over time.
3) Psychology
It takes a special mindset to stay invested when the market or the companies you own are facing headwinds. Here, Buffett has shown an incredible ability to stay calm or even take advantage of the situation to buy up. Nowadays, as an investor, you have to be able to pack away your pride, accept that you will sometimes be wrong and sell your position – even if it’s at a loss. It sounds so simple, but it’s not easy in practice.
“You’re got to align your portfolio with your skill set”
