Welcome to part one of our four-part series on the world’s top investing strategies.
In this series, I’ll reveal the specific strategies that famous investors used to multiply their wealth. Some of the names you might recognise: Warren Buffett, Peter Thiel, Mark Cuban, George Soros, or Carl Icahn…and about 20 more.
Each of these guys are ‘in-tune’ with the world of money…and have gotten good at navigating it.
And even better, I’ve studied each guru and strategy…and I’ve thrown all the best gems in this series.
Over the next few days, I’ll give you a quick rundown of how they designed their strategies, how they work and how you can apply them in your own portfolio.
Today we’ll cover one of the most popular styles of investing today — Value Investing — and four wildly successful investors who fall into this school of thought.
Benjamin Graham was born in 1984 in London. His family moved to New York City while he was young…and there he grew up. He eventually attended Columbia University, where he graduated as the salutatorian of his class.
Right away, he was inundated with offers to take his wit into the world of academia as a teacher of math, English, or philosophy…but luckily for us, he declined them all.
Instead, Graham took his talent to Wall Street…where he began the Graham Newman Partnership.
Throughout his career on Wall Street, he made a science of investing…defining terms and developing analytical systems. He realised that there’s a lot more to investing than just betting on a stock like you would a pony.
He found that the fundamentals of a business, which can be found in their financial statements, can be used to understand their value and predict their trajectory.
In other words, Graham realised that numbers matter…and if you ignore the numbers, you may as well be buying lottery tickets.
This was the birth of what’s now called ‘value investing’…making Graham the ‘father of value investing’.
His philosophy stressed the importance of buying and holding for the long-term. He even suggested that an intelligent investor shouldn’t be concerned with the erratic daily fluctuations in stock price.
If you’ve smartly picked a fundamentally strong business, your stock will generally increase in value over time. In the short-term, the stock market behaves like a voting machine, but in the long-term, it acts like a weighing machine.
Graham’s ideas were proven profitable by his student, Warren Buffett.
Hopefully, you’ve heard Warren Buffett’s name before. He is, after all, the third-wealthiest person in the world…having a net worth of about US$80 billion.
He took Graham’s ideas and put them into action…and he found that they worked remarkably well.
Born in Omaha, Nebraska, Buffett grew up as the son of Congressman Howard Buffett. He was a natural entrepreneur…selling golf balls and stamps, detailing cars, and delivering newspapers.
He filed his first tax return at the age of 14…making a $35 deduction for the use of his bicycle and watch during his newspaper route.
He spent his early career learning the ropes alongside Benjamin Graham. He discovered that bargains existed on Wall Street, and he just needed to find them. Among other businesses, Buffett bought out a textile manufacturer called Berkshire Hathaway.
The first shares he bought cost him $7.60 a share. Today, Berkshire Hathaway stocks run north of US$300,000 each.
The business soon began to focus on the insurance industry, using the cash flows from those businesses to allow Buffett to hunt down bargains in other sectors. That model continues today.
Over the years at the helm of Berkshire Hathaway, Buffett wrote annual shareholder letters in which he reveals the nuances of his successful investing strategy.
When he looks at potential companies to buy (through shares), he goes through a checklist of 12 ‘tenets’ to evaluate if the business is worth it or not. Here they are:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the business have favourable long-term prospects?
- Is management rational?
- Is management candid with its shareholders?
- Does management resist the institutional imperative?
- Focus on return on equity, not earnings per share.
- Calculate ‘owner earnings.’
- Look for companies with high profit margins.
- For every dollar retained, make sure the company has created at least one dollar of market value.
- What is the value of the business?
- Can the business be purchased at a significant discount to its value?
Asking these questions before investing has made Buffett a wealthy man…and made Berkshire Hathaway a profit-machine. But the company’s growth has also been due to Buffett’s partner in crime, Charlie Munger.
Charlie Munger grew up with Warren Buffett in Omaha, but the two split ways for most of their young adult lives. While Buffett worked on Wall Street, Munger went to Harvard for his law degree and spent time in the military.
He eventually moved to California and developed his own investment-management company. He became the chairman of Wesco Financial Corporation, which Berkshire Hathaway eventually bought outright.
Munger and Buffett joined forces in the early days of the investment management venture…and worked as partners (as Buffett describes the relationship) to the present day.
While the two men employ similar strategies, their central pillars differ slightly.
Munger’s main tactic is to hold a concentrated number of stocks that he knows extremely well in order to produce superior returns.
In other words, keep it manageable.
If you’re spreading your investments across dozens of businesses, you’re going to have a hard time keeping up each one. Instead, focus on a few companies which meet your investing criteria…and then stay current on everything that happens within that business.
Some of Munger’s early picks included Coca-Cola, Wells Fargo, Procter & Gamble, and Goldman Sachs.
Munger is also known for his term, the ‘Lollapalooza effect’. This effect basically refers to the various social pressures that can cause people to act irrationally. Pressures include…
- Reciprocity — where you feel you owe someone because they gave something to you.
- Consistency — if you agree to small things, you’ll likely agree to bigger things.
- Social proof — everyone else is doing it, why not you?
When these pressures come together, it becomes likely that you’ll act irrationally. This is a critical concept in the world of investing, where irrationality can lead to stock crashes or bubbles.
The Value Trio
These men — Benjamin Graham, Warren Buffett and Charlie Munger — represent the three top minds in the world of value investing.
Their approach focuses on the financials of the business, its potential for long-term growth and its management. If a company fails to check those boxes, it never makes it to the portfolio. But if it does, these gurus would suggest buying and digging in for the long run.
It’s a strategy of patience and elbow grease.
To make money here, you’ll need to spend many hours studying financial statements and press releases…then repeat for 50 years.
But it works.
Warren Buffett going from nothing to $80 billion is a testament to the effectiveness of value investing.
If you’re interested in learning more, I’d encourage you to check out Warren Buffett’s annual letters to shareholders of Berkshire Hathaway, Benjamin Graham’s The Intelligent Investor and Munger’s Poor Charlie’s Almanack.
Read those and you’ll be well on your way to building your own value portfolio.
Editor, Money Morning New Zealand
PS: Keep an eye out for the next instalment in this series. We’ll dive into the strategy of Contrarian Investing…and the famous investors who employ it. I’m talking about people like Jim Rogers, John Templeton, Marc Faber, and more. I’m excited to send it to you!