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.