The stock market has been reeling in recent days from mounting geopolitical risks and uncertainty. Jittery stock markets can make for jittery investors. But one investor who has made billions of pounds over the decades thanks to nervous markets is Warren Buffett.
How has he done it?
Focus on the facts, not the fears
One element of Buffett’s success has been separating market hysteria from the facts on the ground.
Many people know Buffett invested in American Express (NYSE: AXP) decades ago: Berkshire Hathaway continues to own the shares. Amex seems like a classic Buffett stock market pick. It has a strong brand, proven business model and long-term profit potential.
It also has risks too. Weakening US consumer confidence could lead to higher credit card default rates, hurting profits.
But what fewer people know nowadays is that Buffett bought when one risk was seen as especially notable by the market, which had marked down American Express stock accordingly.
That risk was an accounting fraud involving vegetable oil that affected one of the company’s subsidiaries. Buffett correctly assessed that, as the company was not implicated in the fraud and the financial impact on it was manageable, the share price crash had been overdone. He used it as a buying opportunity.
Quality, always, and without exception
Sometimes though, a market meltdown can make it hard to separate fears from facts. A market fall can become self-fulfilling, weakening formerly strong businesses and then ultimately sending them to oblivion.
That happened to some financial services businesses during the 2007-08 financial crisis. Some were badly run companies but others, arguably, were just in the wrong place at the wrong time.
Such a market crash presented opportunity – but also risk. Buffett’s response was a masterclass in why he became a billionaire.
He was asked to invest in Bear Stearns, then a sizeable investment bank. He spent an evening reading its annual report. He saw enough red flags from that alone to decide he did not need to spend any further time considering the idea.
That’s right: an annual report really can be that useful. For a small investor like me, that in itself is a very valuable lesson from Buffett’s behaviour during the crisis.
But another one is his investment in Goldman Sachs, because it shows how Buffett always prioritises business quality.
Bottom fishing can be dangerous
That sounds simple enough. Who doesn’t like a quality business? The answer is: lots of investors!
In a crash, as share prices plummet, they may think the returns look better from a good business marked down to a rock bottom price, rather than a great business at a merely attractive price.
Buffett has been around long enough to know that quality matters and is worth paying for. Having reasoned that there were opportunities and also risks in the bombed out financial sector in 2008, Buffett looked to sort the wheat from the chaff.
Having dealt with Goldman for over half a century, he invested $5bn on preferential terms and ultimately made billions of dollars in profit.
Just as in calm markets, Buffett was not looking for the cheapest looking share he could buy. He was looking to buy into a great business at an attractive price – and he did.
