Why Smart Investors Smile When Markets Fall: Lessons from Warren Buffett
Investment Best Practices from Warren Buffett's 1997 Letter
The Ted Williams Discipline
"We try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his 'best' cell, he knew, would allow him to bat .400; reaching for balls in his 'worst' spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors."
The Three-Part Investment Filter
- Find well-run businesses with sensible prices and excellent economics
When acquiring businesses, Buffett looks for companies that are:- Understandable
- Possessing excellent economics
- Run by outstanding people
- Wait patiently for the right opportunity
"If we swing, we will be locked into low returns. But if we let all of today's balls go by, there can be no assurance that the next ones we see will be more to our liking." - Maintain a margin of safety
"Today's price levels, though, have materially eroded the 'margin of safety' that Ben Graham identified as the cornerstone of intelligent investing."
The Investor vs. Disinvestor Mindset
"If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?"
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall."
"So smile when you read a headline that says 'Investors lose as market falls.' Edit it in your mind to 'Disinvestors lose as market falls -- but investors gain.'"
On Forecasting Market Movements
"We don't attempt to predict the movements of the stock market."
On Business Evaluation
Look for businesses with:
- Splendid long-term prospects
- Unsurpassed managerial corps that is motivated by "the joy of accomplishment, not by fame or fortune"
- High returns on equity
On Using Stock for Acquisitions
"We strongly prefer to use cash rather than Berkshire stock in acquisitions." "When we issue shares in a merger, we reduce your ownership in all of our businesses." "We believe that it is almost impossible for us to 'trade up' from our present businesses and managements."
On Market Downturns
"We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence."
On Evaluating Acquisitions
Paying a takeover premium makes sense only if:
- The acquirer's stock is overvalued relative to the acquiree's or
- The two enterprises will earn more combined than they would separately
The Duck Analogy
"Any investor can chalk up large returns when stocks soar, as they did in 1997. In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world."