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Stay in Your Circle of Competence: Warren Buffett's Timeless Investment Wisdom

By sagebytes —

Warren Buffett's Investment Best Practices

Extracted from Berkshire Hathaway's 1999 Annual Letter to Shareholders

Fundamental Investment Principles

Focus on Intrinsic Value

  • Definition: The actual value of a business based on its future cash flows, not its market price.
  • "Intrinsic value is discussed on page 60 [of the Owner's Manual]. It far exceeds our $57.8 billion book value."
  • Businesses such as See's Candies and Buffalo News are worth "fifteen to twenty times the value at which they are carried on our books."

Stay Within Your Circle of Competence

  • "If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter."
  • "We simply don't get into judgments in fields [where] we bring nothing to the table."
  • "Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter."
  • "If others claim predictive skill in those industries...we neither envy nor emulate them. Instead, we just stick with what we understand."

Look for Businesses with Durable Competitive Advantages

  • "We believe these companies have important competitive advantages that will endure over time."
  • "This attribute, which makes for good long-term investment results, is one Charlie and I occasionally believe we can identify."
  • Seek out management with both skill and integrity, like those who built GEICO, Executive Jet, and See's Candies.

Price vs. Value

  • "If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter."
  • "What really gets our attention, however, is a comfortable business at a comfortable price."
  • "We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated."

Investment Temperament

  • Patience is crucial: "Berkshire will someday have opportunities to deploy major amounts of cash in equity markets — we are confident of that. But, as the song goes, 'Who knows where or when?'"
  • "We have never attempted to forecast what the stock market is going to do in the next month or the next year."
  • "If anyone starts explaining to you what is going on in the truly-manic portions of this 'enchanted' market...remember still another line of song: 'Fools give you reasons, wise men never try.'"

Market Expectations and Reality

  • "Equity investors currently seem wildly optimistic in their expectations about future returns."
  • "We see the growth in corporate profits as being largely tied to the business done in the country (GDP)."
  • "If profits do indeed grow along with GDP...the valuation placed on American business is unlikely to climb by much more than that."
  • "If investor expectations become more realistic—and they almost certainly will—the market adjustment is apt to be severe, particularly in sectors in which speculation has been concentrated."

Share Repurchases

  • Only repurchase shares when:
    1. The company has available funds beyond near-term business needs
    2. Stock is selling below its intrinsic value, conservatively calculated
  • "Buying dollar bills for $1.10 is not good business for those who stick around."
  • Don't repurchase just to "show confidence" or be fashionable.

Acquisition Criteria

  • Look for owner-operated businesses with passionate managers
  • Prefer simple, understandable business models
  • Seek businesses with consistent operating histories
  • Look for favorable long-term prospects
  • Pay cash when possible rather than issuing shares

"We simply ask our managers to run their companies as if these are the sole asset of their families and will remain so for the next century."