What makes Warren Buffett the most successful investors in the world?

Warren Buffett is a successful American business magnate, one who has invested in multiple and various successful business lines operating locally and internationally. According to CEOWORLD magazine Billionaire’s Index, Buffett is ranked as the top 10 wealthiest people in the world with a net worth of about US$111 billion. His high net worth reflects his successful business investment over the years.

He developed an interest in business at a young age, which influenced his career and the course he studied at the university. Buffett initially enrolled in the Wharton School of the University of Pennsylvania in 1946 and later completed his higher education course in the University of Nebraska.

He later proceeded to Columbia Business School where he developed his business philosophy around value investing. Through his American multinational conglomerate, Berkshire Hathaway, Buffett owns about 60 companies operating in various industries. Buffett’s investment success stems from his interest in business and core business values, business philosophy and investment strategy, and a secure investing style.

Why is Buffett a Great Investor?

Warren Buffett has over the years demonstrated attributes that define him as an astute investor and businessman.

An Interest in Business and Core Business Values

From a young age, Buffett demonstrated an interest in business, a characteristic that set the foundation for his investment orientation, career choice, purposive education, and core values. While assessing the importance of having an interest or a passion in a particular career, Forbes business magazine highlighted that passion facilitates a person’s commitment to his work and self-motivation (Gold, 2019). By having a passion for specific fields or careers, people are likely to enjoy their engagement in such fields and do what it takes to succeed.

Correspondingly, having an interest in one’s field facilitates a sense of job satisfaction and the desire to succeed. Passion in investment and business has been the fundamental drive in Buffett’s strategy as exemplified by his key business values, philosophies, investment strategies and the level of effort and resources he invested to succeed. Therefore, having an interest in business and investment helped Buffett to choose and focus on an appropriate careers that worked to his strengths, making it easy for him to achieve self-motivation and engagement.

The influence of his interest in business and investment over his career can be assessed in the context of his educational trajectory and how it aligns with his career choice. His interest in business and investment influenced his career choice and the type of education he chose. Initially enrolled in the Wharton School of the University of Pennsylvania in 1946 and later completed his higher education course at the University of Nebraska.

He later proceeded to Columbia Business School where he developed his business philosophy around value investing. As such, his educational experience aligns with his career choice because he developed an interest in business at a young age. His educational experience provides a solid fundamental structure for the strategic decisions he makes during investment. For instance, his ability to assess and evaluate firms before investment partly stems from his educational experience. He can use assessment tools such as SWOT and Porter’s five forces analysis among other tools to assess the value of firms before buying their shares, leading to smart and effective investment decisions.

Based on this interest in business, he analyzed existing businesses, leading to core value investment values that have brought him success over the years. He bought his first shares from the Cities Service when he was 11 years. The stock price was 38 per piece at the time. His experience from this investment exposed him to America’s business environment. From the moment onset, he developed core investment values that have been influencing his business decisions to date.

Firstly, he observed that investors should buy stock in companies that demonstrate solid fundamentals. Correspondingly, he observed that people should invest in firms that demonstrate reliable and sustainable growth potential over an extended period. A company’s outcomes within a short duration cannot be controlled and may not reflect its true value. As such, the focus of the evaluation is whether the firm can hold its value in the long term and deliver financial success to investors within that period. He also believes that people should invest in companies that demonstrate strong potential for sustained growth over the years. Again, this attribute cannot be assessed in the short-term period but is based on past performances over extended periods.

Business Philosophy and Investment Strategy

Warren Buffett’s business philosophy is one of the important outcomes of his interest in the business. His interest in business drove him to analyze America’s businesses and other businesses across the world. Based on this analysis, he adopted a value investing business philosophy. Value investing involves buying stocks that trade for less than their intrinsic value.

The intrinsic value of stocks includes an objective value contained in the stocks and is often undermined in the market value of such stocks. Various methods can be used to assess the intrinsic value of shares. These evaluation methods use residual income, discounted cash flows, and dividend streams to arrive at the intrinsic values of the stock. Using his sound business knowledge and skills obtained from his educational preparation and experience, Buffett is able to pick stocks whose market values are less than their intrinsic values or underestimated in the stock market.

Because the market overreacts to events and news, the stocks of companies with significant growth and revenue potentials are often under-valued. For instance, the market value for a company’s stock is likely to plunge following the news of the exit of its long-term CEO. Correspondingly, the market value of several companies’ stock reduced significantly from the onset of the COVD-19 outbreak following the adverse impacts of the pandemic on businesses. Therefore, people tend to overreact to news about companies in ways that do not reflect the market value of their stocks realistically

As part of his investment strategy, Warren Buffett picks companies with a stock whose market values are undermined in the stock market. Such companies have significant financial potential when assessed based on their history and ability to turn things around in the long term. Buffett realized that people tend to overreact to bad or good news in ways that affect the market value for stock (Chirkova, 2012). However, such market values do not reflect the true potentials of companies.

In time, the stock would regain its accurate market value. Based on Buffett’s analysis of the American business environment, he concluded that no company truly ever dies. Some of the negative financial projections about firms and their performances are circumstantial and do not reflect their long-term potentials for growth and profitability. As such, Buffett has always invested in companies whose stock are under-exterminated in the market but has immense intrinsic value. Working with this investment philosophy, Buffett has always generated significant returns from his investments over the years, making him a great investor.

Warren Buffett’s investment strategy has significant support from studies. For instance,  a study conducted by Chan, Jegadeesh, and Lakonishok (1995) found that investment in stocks with low price-to-book multiplier generates significant returns in the long run than stocks with a high price-to-book multiplier. According to Caj (1997), stocks with low price-to-book outperforms glamour stocks by 6% to 12% per year for five years after the formation of the portfolio.

A study conducted between 1975 and 1998 on British public companies confirms the above observation. The study indicates that value investing yields a higher return on investment than investment in glamour stocks because it exploits investors’ mistakes and tendency to overreact to information about companies (Lakonishok, Shleifer & Vishny, 1994). Value investments are not riskier as perpetuated in the stock investment discourse as long as companies are objectively evaluated based on their long-term potentials and financial histories. Buffett understood this fact and modelled his investment philosophy around it, leading to his successful investment decisions over the years.

Investing Style

Warren Buffett’s investment style is partly responsible for his investment success over the years. His investment style includes four tenets, including business decisions, management decisions, financial measures, and value-related decisions.

His business decisions include the type of businesses he considers for investment. To meet his eligibility criteria for investment, Buffett only focuses on businesses he can analyze in a straightforward manner. Such businesses must have clear and non-ambiguous operational philosophy that can be used to assess their history and predict their performances. These criteria protected Buffett from the financial losses that many investors incurred during the dot-com bubble in the early 2000s. The bubble was facilitated by the unprecedented market rise amidst increased speculation regarding high technology-related stocks. Buffett is one of the few investors who did not buy technology-related stocks because most technologies were new and unproven.

The management tenet of his investment style focuses on whether companies strive to optimize shareholder values. He analyzes companies he is interested in to determine whether they tend to re-invest part of their profits or distribute them to shareholders. He favours the distribution of profits to shareholders or the maximization of shareholder values. He also evaluates companies with great potential based on their transparency. He understands that business operations may not be easy or straightforward. However, how companies bounce from temporary setbacks matters a lot to Buffett.

Correspondingly, the ability of companies to demonstrate transparency is critical for developing shareholders’ trust. Lack of transparency can lead to significant financial losses for investors. Enron Corporation is a case in point where financial statements were manipulated to create a perception of a financially healthy organization. Because of this manipulation, many investors bought the company’s stock. However, they incurred significant losses in the long run because the market value of the stocks could not match the company’s financial potential.

Buffett avoids this mistake by evaluating firms based on their ability to demonstrate transparency even when they incur losses or mistakes in the course of their operations. Lastly, Buffett focuses on firms that make strategic innovative decisions as part of their strategies for overcoming business challenges and adjusting to their environments. Innovative companies demonstrate that they can withstand shifts in their business environments and remain relevant for extended periods. Because value investing focuses on the long-term potential of firms, innovative companies are safe or less risky considering that they can survive for extended periods through innovation.

His tenets on financial measurement focus on profit margins and economic value-added profits. By assessing a company’s profit margin, Buffett is interested in companies with low operational costs and high profits. By keeping their operational costs low, such companies offer safety against potential financial losses. Secondly, Buffett evaluates companies based on their financial health following value-added calculations. This calculation reveals a company’s profit after shareholders’ stake is distributed. In other words, it calculates a company’s profits minus the initial cost of acquiring capital from investors. The relevance of this calculation is to assess whether companies can sustain high-level shareholder values for an extended period, giving investors a significant return on investments.

Lastly, value tenets focus on a company’s intrinsic value. The intrinsic value of stocks involves an objective assessment of the value contained in the stocks that are undermined in their market values. Various methods are used to assess the intrinsic value of shares. These evaluation methods use residual income, discounted cash flows, and dividend streams to arrive at the intrinsic values of stock. As observed above, stocks with low price-to-book generate significant returns in the long run than glamour stock (Chan, Jegadeesh & Lakonishok, 1995). These business tenets help Buffett to make effective investment decisions.

Conclusion

Buffett’s investment success stems from his interest in business and core business values, business philosophy and investment strategy, and a secure investing style. From a young age, Buffett demonstrated an interest in business, a characteristic that set the foundation for his investment orientation, career choice, purposive education, and core values. Warren Buffett’s business philosophy is one of the important outcomes of his interest in the business. Warren Buffett’s investment style is partly responsible for his investment success over the years.

References

Cai, J. (1997). Glamour and value strategies on the Tokyo stock exchange. Journal of Business Finance & Accounting, 24(9‐10), 1291-1310.

Chan, L. K., Jegadeesh, N., & Lakonishok, J. (1995). Evaluating the performance of value versus glamour stocks.  The impact of selection bias. Journal of Financial Economics, 38(3), 269-296.

Chirkova, E. (2012). Why is it that I am not Warren Buffett? American Journal of Economics, 2(6), 115-121. DOI: 10.5923/j.economics.20120206.04

Gold, E. (2019). The Importance of Passion as a Business Leader. https://www.forbes.com/sites/theyec/2019/07/08/the-importance-of-passion-as-a-business-leader/?sh=613cb30f21d1

Lakonishok, J., Shleifer, A., & Vishny, R. W. (1994). Contrarian investment, extrapolation, and risk. The journal of finance, 49(5), 1541-1578.