💸 “Rule No. 1 is never lose money. Rule No. 2 is never forget Rule No. 1. Someone’s sitting in the shade today because someone planted a tree a long time ago. If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” - Warren Buffett.

Warren Buffett is one of the most successful investors of all time. He bought his first stock at age 11 and today runs Berkshire Hathaway, which owns dozens of companies. He has also promised to donate over 99% of his wealth. This episode explores Warren Buffets approach to investing, his 6 investing rules, and a million dollar bet that proves why his advice is worth listening to.

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Who is warren buffet?

• If you’ve looked up investing, you’ve probably come a cross his name. Or perhaps you have already heard about him dubbed as the “Oracle of Omaha”. Oracle, because he is one of the most successful investors of all time. Omaha is the city where Berkshire Hathaway (BH) is based. Buffet is currently its chairman and CEO – he is 91 years old.

• Every year, at the Berkshire Hathaway Annual Meeting, Warren, his friend and associate Charlie Munger – 98 years old – offer their views on:

  • their portfolios (which stock they sold or bought)

  • the latest investment trends (like bitcoin or SPACs (A special purpose acquisition company, also known as a "blank check company", is a shell corporation listed on a stock exchange with the purpose of acquiring a private company, thus making it public without going through the traditional initial public offering process)

  • the macroeconomic outlook

  • answering shareholder’s questions.

• These meetings usually last hours and can be time-consuming to watch, but the investment community scrutinise any change of views or any change in their portfolio. As of June 2022, BH had a market cap of $604.31bn, so any small changes could mean big money. To put it in perspective, the fund is larger than what Poland, or Sweden or Belgium produces on a yearly basis. Impressive, so how did he do it?

What is value investing?

• Warren Buffet is the quintessential value investor. From a very young age he has shown strong number skills. Not only Buffet was good at it, but he also enjoyed deep diving into companies’ financial statements.

• A value investor will look at a company's accounts and will assess whether this company is undervalued versus where the company trades in the stock market. In practice, he will sum all the assets and liabilities of a business – also called intrinsic or book value [a little bit like you when you calculate your net worth!] - and compare it to its market capitalisation (value of its shares traded on the stock market).

• Market cap is the total value of all a company's shares of stock. It is calculated by multiplying the price of a stock by its total number of outstanding shares. For example, a company with 10 million shares selling at £20 a share would have a market cap of £200 million.

• The difference between the market capitalisation and the intrinsic value can be explained by expectations. If the outlook for a company is bright, the stock will reflect the future growth by a higher market capitalisation (share price is higher). Similarly, if the outlook is grim, its valuation will take it into account.

• Take ZOOM, for example. As more people began to use it at the beginning of the pandemic, its market capitalisation exploded (shares went up). From January 2019 till its peak in October 2019, its market capitalisation increased over eight times. With more people using the software, the market was pricing this exponential growth. As vaccines were approved and the crisis started to ease, its valuation plummeted by over 80%. ZOOM is what we call a growth stock. It is a company with high potential returns fuelled by exponential growth which usually requires a lot of cash and generates little revenues at the beginning.

• Ideally, a value investor looks for stock where the intrinsic value is inferior to its market capitalisation. That simply means that the market hasn’t realised yet the future growth of a company.

Warren’s 6 investing rules

What kind of stocks would Warren buy? Apple!

1. A company with growing steady cashflows. A company that generates cash regardless of the economic environment (the company is therefore less likely to go bust during economic downturns). BH first bought Apple in 2016 and is now its largest shareholder. [https://www.statista.com/statistics/267728/apples-net-income-since-2005/ As this chart shows,] Berkshire Hathaway only started to buy once Apple had a proven track record of generating revenues. As per its investor website: “Apple went public on December 12, 1980, at $22.00 per share. The stock has split five times since the IPO, so on a split-adjusted basis the IPO share price was $.10.” A stock split is when a company increases the number of its outstanding shares to boost the stock's liquidity. Although the number of shares outstanding increases, there is no change to the company's total market capitalization as the price of each share will split as well. Its average price in 2016 was $26. A value investor is happy to miss this 26,000% return since IPO (which is considered the risky period) and buy when the company may generate less return but more steadily.

2. Steady growth = long term returns. WB famously said: "If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes." and “Our favourite holding period is forever”. Therefore, do your homework and then trust your decision. As we mentioned several times at Vestpod, less trading equals less fees / more to invest, less stress / more happiness.

3. Company with a moat or a company that produces something that no one else provides. Apple is again a very good example since it makes products that no one else offers. The moat also allows pricing power, the company can raise prices on its product without affecting demand.

4. Dislike buyback or dividend. Buffet’s view is simple: if you are returning cash to investors (i.e. paying dividends), it could mean that you have no more areas to invest in and therefore your future growth could suffer. There are exceptions to this rule, and Apple is one. Indeed, Apple generates so much cash ($365 billions in 2021) that it would not be able to reinvest it all. In that case returning cash to investors is acceptable!

5. Prefer cash to poor investments. I often get asked: “why do people have cash in their portfolios?” Berkshire Hathaway was sitting on around $40bn worth of cash at the end of Q1 2022 down from $88bn at the end of 2021. Although it can be itchy to invest sometimes, it is also wise to keep cash to put to work when better opportunities arise. The stock market plunge at the beginning of 2022 is proof in the pudding. You will note that BH used the dip to deploy a significant amount of its cash pile!

6. Avoid business that you don’t understand well. Valuing a business and understanding it can be different. The value will give you an instant snapshot of its health, while understanding it will give you insight into its future. As we noted earlier, the market will adjust for future expectations. Therefore, if you are not 100% confident you understand a stock or anything else you should stay away from it.

We hope you enjoyed this episode - we are recording another one about Cathie Wood very soon!

*** Our podcast partners PensionBee are also offering you a £25 pension contribution (£20, plus £5 in tax relief) when you sign up. To claim the offer, follow this link: https://www.pensionbee.com/vestpod. Capital at risk. ***