With his record as one of the most successful investors in history, I doubt I will match the returns of Warren Buffett. But even if I do not end up in the same league, I think I can improve my investment returns by applying lessons I have learnt from Buffett’s approach.
Here are five practical ways I can apply the Sage of Omaha’s investment approach to my own portfolio as a private investor.
1. Do a lot of research
It consistently surprises people that the way Buffett spends most of his working day is sitting in his office alone, reading. Buffett typically reads hundreds of pages a day and has done so for decades.
Some investors think that to spot the next big thing, it is crucial to get out to industry events or travel around looking for inspiration. Buffett does little of either, preferring to bury his head in the written word. The reason for that is simple. In the US and the UK, companies are required to file regular reports including financial statements. They include useful information such as revenue, profit, cash flow, and much more. As the accounting approach within a stock market is largely standardised, it is relatively easy to compare one company to another. While some firms may talk a good game or camouflage their figures beneath unusual accounting metrics, the use of standardised formats can allow an experienced investor like Buffett to see through such efforts.
A company’s report can help him understand how it is doing and what sort of competitive advantage it may have. The financial reporting element can also help him understand in cold, hard numbers how the business is performing. This sounds like basic stuff – and to some extent, it is. Yet often people are taken in by charismatic executives, talk of shifting customer behaviours, and the fear of missing out. Buffett ignores all that chatter and instead just sits and reads.
As a private investor, I can do the same, for free. Not only do I think it can help me spot good opportunities before some other investors do, it can also help me stay away from shares whose accounts raise too many red flags for my comfort.
2. Keep things simple
I do not think I need to understand a wide variety of industries or business models to become a successful investor. But I do want to make sure that if I invest in a company, I understand the basics of how it makes money.
Looking at some of Buffett’s portfolio, it is notable that he owns a number of companies with very simple business models, such as Coca-Cola, American Express, and Chevron. Not only do these companies have simple business models – the models have hardly changed in decades – they could still be using the same business model decades from now, in fact.
That is not a coincidence. The less a company changes what it has to do to make money, the less risk there is that it could make a strategic mis-step that eats into its profitability. That does not always work, as sometimes the ground changes beneath a company’s feet as the market in which it operates shifts. That is why Buffett looks for markets where he expects demand dynamics to stay roughly the same. He reckons people will still drink cola, make payments, and use oil for decades. So the three holdings above could continue to profit from such behaviour. In a world where many so-called investment experts try to bamboozle people with complexity, it is refreshing to see Buffett’s successful approach is focused on simplicity. I can easily apply a similar frame of thinking to my own investment choices.
3. Buy good shares and hold them
Buffett is not a trader, he is an investor. His investment time frame is typically not just years, but decades.
Applying the sort of long-term approach Buffett uses when investing to my own portfolio decisions can help me in a number of ways, I think. At a practical level, trading less often can reduce my fees. Over time they can mount up, so that is helpful.
But it should also enable me to benefit from the long-term success of companies. Sometimes it can be tempting to sell a share after it moves up 20%, 50%, or 100%. But if I invest in high-quality companies with sustainable competitive advantages, selling too early may cost me the majority of the gain I could make. That is why, like Buffett, I aim to buy shares in great companies and then hold them for long enough that my investment thesis is hopefully proven in a very big, profitable way.
4. Warren Buffett diversifies
Another way in which I can easily draw inspiration from Warren Buffett for my own portfolio is not putting all of my investment funds into a single company.
Even though Buffett has had some very successful investments, such as Apple, he has always diversified his portfolio by holding shares in different types of business at one time. That means that if one company unexpectedly performs poorly, the impact on his overall portfolio will be reduced. That is a very simple risk management principle – but I still think it is a valuable one I can apply to my own portfolio, no matter what size it is.
5. Focus on business models over management
Many investors see Buffett himself as the reason for success of his company Berkshire Hathaway. Despite that focus on a single executive, Buffett himself does not invest in other companies purely because he respects their management.
That is because management can change. Eventually, indeed, every company will change its managers. If profit depends on them personally, that could be bad news for shareholders. That is why Buffett regards good management only as a bonus, not a reason to invest in itself. Instead, he looks for a company to have a business model that gives it an enduring competitive advantage. That could be a unique technology, well-developed brand, or market monopoly. But whatever it is, Buffett buys companies for their business models and prospects – not their leaders.
