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The business of value investing – Six essential elements to buying companies like Warren Buffett- Charlie Tian 2009
https://bbs.pinggu.org/thread-695143-1-1.html(Page 58-65)
Learn from the Masters, The Sum of Its Parts- A Fundamental Framework, All Investing needs to be Value Investing
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Fortunately, we don’t all have to be like Buffett and be “wired at birth” for investing. We do need to understand that successful value investing hinges on activities that you are trained not to pursue and often requires that you do the exact opposite of what the majority is doing. As Buffett often says, you pay an expensive price for a cheery consensus.” Some of the best bargains usually are found in industries that are currently under distress, where investment dollars are exiting and not entering. If you want to invest in the cocktail party stock of the year, the idea won’t come cheap. For example, we are taught that a highly diversified portfolio is the soundest approach. For the general individual, this might be an intelligent way to go. But if you’re a serious investor and are devoting serious time to stock selection, then concentration makes the most sense. The wealthiest people on the planet have derived their wealth from a single business: Warren Buffett from Berkshire Hathaway; Bill Gates from Microsoft; Lakshmi Mittal from ArcelorMittal; and on it goes. It’s silly to think that just having a few eggs in your basket is riskier than having more. If you know the business cold, why put money in something else that you don’t know as well? As Buffett suggests, it is better to have a few eggs in your basket and watch them closely than to have many and risk some breaking.
In observing great investors, It is discovered that their investing approach hinges on six elements that comprise the entire investment process. These six elements always go together in selecting investment candidates; in other words, you can’t have a good search strategy (Element 2) without first having a sound investment philosophy (Element 1). Just like crawling before walking, you need to know what you’re looking for before beginning to look. Jumping ahead and investing without understanding what it is you’re looking for often will send you into a crash. At first, the framework looks obvious; all of the individual pieces have been discussed and dissected in other investing literature. Here, it’s the total framework that counts, not the individual components. This is not a checklist that you go through every time you want to pick an investment but rather six essential elements that should truly exist if you are a value - seeking investor. It is surprising how few “value investors” actually invest with this mental framework in mind. Referring back to Graham’s definition of an investment operation, relatively few investors truly take the time to analyze the business and determine whether the price is right so that a satisfactory return is achieved . Investing in this manner is not easy to do. It requires discipline and no emotional attachments. Emotions are the enemy of the disciplined investor. Maintaining discipline minimizes the severity of mistakes. The key to successful investing is not to eliminate mistakes, which are inevitable, but to minimize their impact on the overall investment portfolio. Investors should not take this viewpoint to mean that investing is a rigid science. On the contrary, investment is part art and part science with a little luck thrown in on the side. The framework to be outlined hardly suggests that investing is a rigid discipline. Rather these elements are essential fundamentals that enable each unique investor to succeed in his or her own way. All golf swings are different, but attention to the essential elements of a pure golf swing - keeping your head still, a good shoulder turn, and maintaining plane — all serve to keep the ball flying accurately. Similar to golf, the essential elements in investments all work together to produce a consistent and effective selection strategy. True value investing often requires that you look stupid in the short run. Often you will own shares in businesses that are hated by the majority. With each passing month that goes by without anything positive happening, the criticisms will get louder. You must have complete faith in your decisions or else you will be guided by the crowd. And most important, value investing requires total and complete independence of thought. The ability to sit still for months while your investments do nothing and have all the “smart money” berate you for having completely missed the boat requires a very independent and emotionless state of mind.
During the Internet boom of the late 1990s, Berkshire Hathaway’s stock price was tested as never before under Buffett’s watch. Reporter after reporter was quick to criticize Buffett for not having participated in the Internet boom. In December of 1999, Barron’s ran a cover story titled “What’s wrong Warren?” The first sentence of the article was “After more than 30 years of unrivalled investment success, Warren Buffett may be losing his magic touch. ” What sparked such an opinion? Shares in Berkshire were set to decline for the first time since 1990. Thankfully for Berkshire investors, Buffett spends no time paying attention to what the media thinks about his investments. So for Buffett, his aversion to the Internet companies was simply an exercise in discipline. With billions of dollars at his disposal, he could have easily allocated tens of millions of dollars to a basket of Internet stocks and not affected Berkshire’s performance if they all lost money. But he didn’t do that because doing so would have taken him outside of his circle of competence. This is a very important lesson and one Buffett has alluded to over and over. If you’re not willing to risk millions in an endeavor you don’t fully understand, then you shouldn’t be willing to risk thousands. An intelligent investor seeks to avoid all losses and does not differentiate between a “small” and a “ big ” loss. Just as Tiger Woods adheres to a concise and disciplined set of steps for each and every golf swing, so does the value investor in selecting stocks. In order, these six essential elements are:
1. Commit to a sound investment philosophy.
2. Find a good search strategy.
3. Effectively value a business.
4. Have the discipline to say no.
5. Be patient.
6. Be willing to make a significant bet at the point of maximum pessimism.
This framework — ingrained in the minds of Warren Buffett, Charlie Munger, Mason Hawkins, Seth Klarman, and others — provides a complete mental approach to investing that, if rigorously applied,
will eliminate many unforced errors in investing. All investors make mistakes, but the most successful investors are those who are best able to avoid the unnecessary mistakes and to avoid making the same mistakes twice. Also, when investors apply and commit to pursuing investing based on the six elements, they are conditioning their minds to be more disciplined in making investment decisions, and a disciplined approach is a much more focused approach.
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As mentioned earlier, many value investors have come across the individual components of this process. Warren Buffett’s annual reports are littered with references to a sound investment philosophy, patience, and discipline. Buffett’s partner Charlie Munger often extols the virtues of patience. The key to this framework is viewing it as a series of building blocks, or- to borrow a term from Charlie Munger- a latticework within investing. It’s a latticework because you can’t have one without the other. It’s ineffective to develop a good search strategy without first having a sound approach and philosophy. Similarly, you won’t be able to make a big bet during moments of maximum pessimism if you don’t have patience or the ability to value a business. Successful investing is not a rigid science defined by one exact formula; it is a continuous, evolving process of constant learning.
The framework can’t be learned in mere months or years but rather applied over and over again over decades. Warren Buffett has been developing a sound investment philosophy his entire life. The foundation of that philosophy began with Graham’s Intelligent Investor, but Buffett has been perfecting it for decades. Charlie Munger often has praised Buffett as one of the “greatest learning machines.” A rational approach to value investing will deliver the desired outcome over a meaningful period of time. It is dangerous. Investors is often to begin searching for the next great investment without giving serious consideration to what it is they actually are trying to accomplish. Every investor’s goal is to buy a security at one price and sell it later at a much higher price. But this goal rarely happens in an orderly fashion, and if your mental approach is not defined by a sound investment philosophy, the odds of costly mistakes are greatly enhanced. The path between buying low and selling high is often littered with bumps, and a patient, business-like approach to investing makes a huge difference. Without an orderly fashion and investment action plan that fail to achieve the profit or finally result in an investment loss.
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