Can I Be as Successful as Warren Buffett?

The world has been fascinated with Warren Buffett, and rightfully so. Berkshire Hathaway has a better performance than any other stock or mutual fund with at least a 30-year history. A dollar invested in Berkshire in 1976 would have been worth $1500 in 2011.

A recent paper by Andrea Frazzini and David Kabiller of AQR Capital Management, and Lasse Pedersen of New York University explains the magic behind the wizard’s performance.

In ‘Buffett’s Alpha” (November 2013, posted in the Resource Center at https://www.joycompass.com/resource/buffetts-alpha-the-source-of-buffetts-success) the researchers boil down Buffett’s success to the main three factors.  If you want to succeed like the master, here are the investment strategies to remember:

1.     Buy cheap, safe, quality stocks
What exactly does a cheap, safe, quality stock mean? Safe means that the stock is less volatile than the market. Cheap requires no explanation (Buffett once quipped that whether it came to socks or stocks, he liked buying quality merchandise when it’s marked down). Quality means finding companies that are profitable, stable, growing, and pay high dividends. 

2.     Borrow Money Cheaply

Stocks that are cheap, safe and high quality outperform the markets in general, but Buffett’s returns were magnified by leverage (borrowing money). On average, Berkshire leveraged its capital by 60%. The remarkable component, though, was Buffett’s use of the premiums collected by his insurance and reinsurance companies. Because insurance companies collect the premiums first and pay claims later, he could borrow a third of his funding at 2.2%, more than three percentage points cheaper than the U.S. government paid on its average short-term debt. The rest of the funding was at a low cost as well because Berkshire’s debt was AAA-rated from 1989 to 2009.

3.     Have the courage to stick to his convictions longer than his competition

Many investors will recall that Berkshire had some down years, as when the company lost 44% of its value when the rest of the stock market gained 32%. Buffett’s conviction, stellar reputation and a stable source of funds helped him survive a 76% shortfall. Buffett’s tenacity as an investor is legendary. Not only had Buffett recognized the principles of the value investing and leverage, but he has also unerringly followed them throughout the years.

Warren Buffett has famously followed the Value Investing school taught at Columbia University. When I was studying there, Graham and Dodd were required reading. If you are interested in learning about investing, I highly recommend starting with Graham and Dodd’s Security Analysis.

Why hasn’t Buffett’s success been replicated more often? Pension and mutual funds cannot use leverage. They resort to buying volatile stocks to increase returns, thus leaving safer stocks undervalued. And for the individual investor? All you need is Graham and Dodd’s book and a cheap pile of cash. 

If you enjoy learning from Warren Buffett as much as I do, I have a summary of his last (2014) annual letter that explains Buffett's four fundamental investing principles available at https://www.joycompass.com/article/buffetts-4-fundamental-investing-principles-from-the-2014-annual-letter.