What advice does Warren Buffett offer investors? In his December 2019 paper entitled “Introduction to the Essays of Warren Buffett: Lessons for Corporate America”, Lawrence Cunningham summarizes main themes of the 5th edition of the essay collection (letters to shareholders), including those related to investing. Based on the advice in these letters, he concludes that:
- Investors should ignore modern portfolio theory and other quasi-sophisticated views of the market. Either make long-term investments in a broad stock index fund, or conduct hard-headed, knowledgeable fundamental analyses of specific firms.
- Do not equate volatility or beta to risk. For example: (1) a very sharp drop in stock price compared to the market elevates beta, but the stock cannot be riskier at its lower price than at its previous price; and, (2) beta reveals nothing about the riskiness of the underlying business.
- Risk rises when investments and investment analyses are spread too thin. Investment and mental concentration can reduce risk by raising (1) the intensity of thinking about a firm and (2) the comfort with its fundamentals needed to buy it.
- Assessing value and risk of loss in a specific investment requires thinking about firm management, products, competitors and debt. The essential question is whether after-tax returns on an investment are at least equal to the purchasing power of the initial investment plus a fair rate of return (with an in-depth look at undistributed earnings). A margin of safety is essential in such estimation.
- Portfolio churn (buying and selling) to maintain some beta-risk target defeats long-term success due to bid-ask spreads, fees and commissions, and taxes.
- Distinguishing between growth and value is spurious. Growth is an integral component of true value.
- Strategies that do not compare price and value are speculation, not investing. Deciding whether to employ cash for speculation/arbitrage requires evaluating: probability of the event occurring, how long funds will be tied up, opportunity cost and downside if the event does not occur.
- The value of U.S. investments is extraordinary in the current global context due to economic tailwinds.
In summary, central themes of Warren Buffett’s letters to shareholders are commitment to long-term investment and informed, in-depth analysis of business fundamentals.
See also “Warren Buffett on Investing” and other results of this search.
