The Warren Buffett Method Of Value Investing
Warren Buffett is one of the richest people on the planet. However, unlike his friend Bill Gates and most of the other people on the rich list, Buffett didn’t get there by starting a business. Neither did he start out wealthy. Instead, at an early age, Buffett developed an interest in investing in the stock market, and he has spent his entire life becoming very, very good at it. One of the things that makes his investment strategy fascinating is that it isn’t difficult. In fact, it’s almost so simple that anyone can copy it. The only trick is that it takes some discipline.
The core ideas behind Buffett’s investment strategy were developed at Columbia Business School by Benjamin Graham, often called the father of value investing, and his colleague David Dodd and explained in the classic investing book “The Intelligent Investor”. Those ideas are relatively easy to understand: find a company with solid financial performance and a growing cash flow, whose stock is undervalued by the market, buy the stock, and hold on to it for a long time. Along the way, ignore everything the market is telling you about which stocks are hot and ignore upturns and downturns in the market. Your job is simple: find valuable stocks that you can buy at a discount – ignore everything else.
Berkshire Hathaway, the investment company Buffett runs with his long-time partner Charlie Munger, who are now both in their late 80s / early 90s, has been based on these ideas since 1970. Over that time, their fund has returned an average of 19.7% compound growth per year. The S&P 500, like the ASX 200, tends to return an average of around 10% per annum.
Buffett recommends focusing on developing a “circle of competence” – a field of knowledge relating to a particular company or industry that allows you to better comprehend the performance of each company in that sector.
To invest like Warren, we need to learn how to search for good opportunities in the market, “the person who turns over the most rocks wins”, as another legendary value investor, Peter Lynch, describes the process. Most amateur (and a lot of professional) investors get caught up in the emotion of the market, the swings and roundabouts, and consequently invest in poorly run businesses that attract a lot of hype (eg tech start ups), or end up investing in well-run businesses but too late in the cycle, and pay too much for their investment, limiting their returns. Or they get caught up in trying to time the market, something that experienced investors know is fool’s game. Or they try to find the “100 baggers” (industry speak for shares that grow by a factor of 100) – and, in the process, lose money on the stocks that don’t work out.
As another legendary investor, Charles D Ellis says:
“There are old pilots and bold pilots, but no old, bold pilots”.
The most successful long-term investing strategy is to find good quality companies and aim for better-than-average returns over a long time period. Buffett’s rule number one is “never lose money”.
The QAV method of value investing takes all of these principles and encapsulates them into a relatively simple spreadsheet. Tony’s genius was in finding a way to integrate everything he has learned from reading hundreds of books about investing and spending over 25 years practicing them, into a concise list of metrics to pay attention to, and a scoring system that tells him what to buy and what to leave alone. It also tells him when to buy (eg at what price) and when to sell. Being disciplined about using the worksheet allows him to remove all emotion from his investing. It helps him to ignore the market ups and downs, ignore the pundits, and ignore the overall economy. Recession? He doesn’t care. Boom? He still doesn’t care. The worksheet is economy-proof because there will always be certain stocks that are bargains during any phase of the market cycle. Over the last 25 years, Tony’s portfolio has returned an average of 19.5% compound growth and during the Global Financial Crisis of 2008 he saw so many buying opportunities in the market (as everyone else was bailing out) that, instead of selling, he doubled down, picking up bargains all over the place.
As you become familiar with the QAV worksheet, you’ll learn that it grabs a number of indicators of quality and value (hence ‘QAV’) and rates the stock against them. We roll those ratings up into a final “QAV Score” which tells us either to buy the stock or to leave it alone.
It is different to Buffett’s method in several important ways. We aren’t looking to spend our days and nights dedicated to investing (as Buffett has for his entire adult life). QAV is designed for people (like Tony) who would rather spend their days and nights doing other things – golf, family, travel, more golf. So instead of becoming experts on a particular industry, our “circle of competence” is in finding bargains as efficiently as possible and getting on with our lives.
I’ve learned to trust the worksheet because I trust Tony. He uses it for his own investments, and it’s allowed him to be successful at it for decades. I’ve known him for one of those decades and I trust him. As I like to tell people “he’s the real deal”. Like his hero, Warren Buffett, Tony is that rare combination of intelligent, successful, humble, and honest, and happy to teach other people how to do what he does.