Sign in Subscribe

The Hope Diamond vs. The Rhinestone: Buffett's Quality-First Investment Approach

By sagebytes —

Warren Buffett's Investment Best Practices

Distilled from Berkshire Hathaway's 2015 Annual Letter

Core Investment Philosophy

  • Focus on intrinsic value: Book value is just a starting point. True intrinsic value is what matters and often exceeds book value significantly.
  • Long-term perspective: "For 240 years it's been a terrible mistake to bet against America, and now is no time to start."
  • Quality over quantity: Prefer owning "a partial interest in the Hope Diamond than to own all of a rhinestone."

Business Selection Criteria

  • Strong economic moats: Seek businesses with sustainable competitive advantages that protect long-term earnings power.
  • Exceptional management: Partner with honest, talented managers who think like owners.
  • Reasonable price: Even great businesses can be bad investments if purchased at too high a price.
  • Understandable businesses: Invest within your circle of competence.

Capital Allocation Principles

  1. Constantly improve the basic earning power of existing subsidiaries
  2. Make bolt-on acquisitions to strengthen core businesses
  3. Benefit from the growth of investees through both dividends and retained earnings
  4. Repurchase shares when available at a meaningful discount to intrinsic value
  5. Make occasional large acquisitions when opportunities arise
  6. Rarely, if ever, issue Berkshire shares for acquisitions

On Productive Assets

  • Productive assets will always be more valuable than unproductive ones like gold
  • American businesses have delivered and will continue to deliver tremendous value over time
  • Productivity gains (doing more with less) are the key to long-term prosperity

On Market Fluctuations

  • Market volatility creates opportunities for the patient investor
  • "Be fearful when others are greedy, and greedy when others are fearful"
  • Short-term market movements are often disconnected from business fundamentals

On Financial Reporting

  • Look beyond GAAP earnings to understand true economic performance
  • Be wary of non-GAAP metrics that exclude real expenses (like stock-based compensation)
  • Understand the difference between accounting charges that represent real economic costs versus those that don't

The "Big Four" Investment Approach

  • Maintain substantial ownership in exceptional businesses (Berkshire's Big Four: American Express, Coca-Cola, IBM, Wells Fargo)
  • Allow these businesses to compound value through retained earnings
  • Benefit from share repurchases that increase your ownership percentage without spending a dime
  • Receive growing dividends over time

Risk Management

  • Maintain financial strength and ample liquidity
  • Never depend on the kindness of strangers (or new financing)
  • Prepare for inevitable economic downturns
  • Insist on favorable odds before making significant investments

Final Wisdom

"Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard."