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Why Time is the Friend of the Wonderful Business: Buffett's Long-Term Investing Philosophy

By sagebytes —

Warren Buffett's investment best practices

Distilled from the 2010 Berkshire Hathaway Annual Letter

Core Investment Philosophy

  • Focus on intrinsic value - Book value is a useful but understated proxy that provides a reasonable tracking device
  • Take a long-term perspective - "Time is the friend of the wonderful business"
  • Be patient - Keep significant cash reserves to seize opportunities during market turmoil

Business Evaluation

  • Look for businesses with outstanding economics - Seek returns on unleveraged net tangible assets of 25%+ after tax
  • Understand the risk profile - The ability to anticipate effects of economic scenarios not previously observed
  • Evaluate management on their allocation of retained earnings - This affects future intrinsic value dramatically
  • Avoid businesses with significant debt - "Leverage is addictive" and "can be lethal to businesses"

Investment Discipline

  • Never risk what you have for what you don't need - Extreme aversion to financial adventurism
  • Maintain significant liquidity - Hold substantial cash reserves ($10B minimum at Berkshire)
  • Avoid borrowing - "More money has been lost reaching for yield than at the point of a gun"
  • Resist following industry trends - "The other guy is doing it so we must as well" spells trouble

Decision-Making Framework

  • Think like an owner - Approach investments with an owner's mindset
  • Be willing to walk away - The discipline to refuse inadequate prices/terms
  • Compare potential acquisitions against a wide universe of opportunities - Including marketable securities
  • Don't rely on precise calculations - Prefer being "approximately right than precisely wrong"

Value Creation Approach

  • Focus on growing earnings from non-insurance businesses
  • Compound capital at above-average rates over the long term
  • Reinvest earnings rather than paying dividends when returns justify it
  • Evaluate businesses on normalized earnings power not accounting metrics like net income

Management Quality Indicators

  • Look for managers who love their businesses rather than seeing them as stepping stones
  • Find leaders who will have an unusual commitment to their operations
  • Prefer managers who focus on efficient operations via productivity gains
  • Seek managers who communicate bad news promptly rather than letting it fester

"Our goal was to find a 2-year-old Secretariat, not a 10-year-old Seabiscuit." - Warren Buffett on talent selection