By Nick Louth
September 06 2007
Becoming a billionaire seems like an impossible dream. A very few people manage it, though. Most do it through business, as Bill Gates did, some inherit the money as the heirs to Sam Walton’s Wal-Mart fortune have done, and a very few do it through investment.
Of these, Warren Buffett is the best known. He came from an undistinguished background and wasn’t moneyed, but by April this year his personal fortune was estimated at $52 billionn by Forbes magazine. This makes him the third richest person in the world.
His investment record is quite astonishing. If you had put $10,000 in his first investing partnership in 1956, and then switched with him to being a shareholder in his company Berkshire Hathaway you would by 1986 have turned it into $5 million. With reinvested dividends it would be worth much more today.
How did he do it? Well, here are 10 strategies that Buffett uses to make money.
1. Invest in value
Warren Buffett always looks to get $1 for 75 cents. That is true whether the business is as boring as shoes or furniture manufacture, or as complex as insurance. He has invested in all these.
He works by analysing a company’s accounts in the manner recommended by Ben Graham, the father of investment analysis. If a company was sitting on property worth $100 million, had cash of $50 million and other assets saleable at $50 million, but was only valued by the market at $175 million, then that firm would be worth a closer look.
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2. Look for the business franchise
Businesses that work really well over the long-term don’t just build a better mousetrap, they own the patent. A unique asset, like a 100-year title to a rich mineral coal seam close to a steel mill, an airport site by a big city, or a powerful brand like Coca-Cola are all enduring franchises. These companies don’t need to fight on price to get business. They have an unfair advantage.
The opposite of franchises are commodity businesses. There are millions of them, and what they all have in common is that they have to trade on price because they face effective competition.
3. Buy good businesses
This sounds obvious, but isn’t. By Buffett’s yardstick, a good business is one with a high real return on invested capital, rather than with good headline earnings growth. Those returns should be measurable in cash terms. Dividends are a good indicator that cash is available.
4. Avoid businesses run for the short-term
Too many firms have managers who think short-term and act that way. Buffett hates businesses where boardroom insiders sold into temporary market strength or expanded the company through over-priced acquisitions.
5. Patience is a virtue
Having the patience to wait for incredible bargains is a discipline Buffett has used time and again. Market mis-pricing comes around with regularity. Professional fund managers are often under too much pressure to act to be appearing to do nothing, but the small investor can wait without anyone looking over his or her shoulder.
My guess is that Warren Buffett would be keeping a keen eye on how incredibly cheap some British banks have become in the recent market falls.
6. Buying businesses with free cash
Buffett has many times bought into companies that have a huge amount of under-used cash sitting on the balance sheet and then used that to purchase other firms.
In John Train’s book on Buffett, The Midas Touch, he describes how Buffett bought the firm Blue Chips Stamps in 1968 and used the stock of stamps sitting on the balance sheet to turn into cash which he then used to Buy See’s Candies and the Buffalo Evening News. These last two buys came at no capital cost to Buffett himself.
7. Keep it simple and straight forward
Buffett avoids meetings, has no acquisitions department and has a modest personal staff. He doesn’t subscribe to investment fashions, or jargon-laden approaches. For Warren Buffett, investment doesn’t have to be dressed up to work. It makes money in its shirtsleeves.
8. Keep cutting those costs
Cost-cutting and an almost skinflint approach to overheads mark Warren Buffett out from others. This is reflected in his personal life. He still lives in the same modest house he bought in 1958 for $31,000, and drives a very ordinary car.
His own salary is only $100,000 a year, which is about a tenth what the typical chief executive of a similar-sized firm might be paid.
9. Understand the figures
Thinking like an accountant is a pre-requisite for investing like Warren Buffett. He can really get to grips with a corporate engine room, and home in on the machinery which is vital to the generation of profits. Only by doing so can you understand the difference between so-so companies, good ones and great ones.
10. Make money while you sleep
Buffett works hard, but he’s not a workaholic. Having used simple ground rules to ensure that he knows he’s only taking a low level of risk and will be in for the long-term, he’s an investor who can sleep soundly and ignore the panicky movements of the markets.
By Nick Louth