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The Buffett Rational

Friday, March 10, 2006
Warren Buffett seems to be the master at investing in boring companies. He often times invests in “textbook” companies like Coca Cola, Washington Post, and Insurance Companies. There are several reasons why he invests in ‘boring’ companies, and a few reasons why it works so well.

Since Buffett was born in 1930, through the beginning of his life he was affected by the great depression. More importantly, his teachers and mentors were all interested in investment techniques that instead of maximizing growth, minimized loss. He became a student of Benjamin Graham, who preached that an investor should look at the intrinsic value of a company rather than try to predict the market.

The concept behind looking to the intrinsic value of a company is that if you find an outstanding company, even if the stock market does not favor it at the moment, eventually the stock market should reflect the underlying economics of the company. Over the long run, an outstanding company may have some short-term problems such as lawsuits, etc. However, on the long-term they should have tremendous growth.

This method of investing is much safer than speculating. For instance, you might be able to make a huge profit off of companies like Google. However, since there is no previous price history, it is unsure of where the market will eventually level off. This makes that investment very risky for the long-term investor because it may level off at a price much lower than its current value.

Now Buffett tends to invest in boring companies because he tends to invest within his “circle of competency.” If he does not understand how a company operates, he will not invest in it. Complex, or highly speculative companies are also quite difficult to valuate, which makes it hard to purchase them at good prices. However, with many financial companies, it can be much easier to determine their worth.

Finding undervalued companies with simple operating structures is not Buffett’s only goal however. He also puts a very high weight on the management of a company. Because to Buffett, a company with outstanding management with an interest that is the same as an owners interests will yield good results in the long term.

Warren Buffett does not put much thought into the price of the stock market. It only concerns him when he is buying a stock. He will not get concerned if the price of the stock is dropping in the short term, as investors often sell for foolish prices. He has been known to sell shares when he thinks the market is overvaluing a company.
When Warren Buffett looks to buy a stock, he often looks for markets where the people are fearful. His thinking is that when investors are fearful, they will often foolishly sell their stock at a low price. If you wait for everyone to say buy, you will end up being the one paying the high price: “The future is never clear, you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values" (Warren Buffett.) He equates this selling at a low price because of fear to a farmer telling his real estate agent to sell the farm whenever a nearby farm sells for less than the previous market price.

The most interesting part about the way Buffett invests is that he does not ever have to get concerned with the daily fluctuations of the stock market. That would make this type of investing quite ideal for someone investing in their retirement fund. Just like it works out well for his insurance float money.

Thanks to the Carnival of Investing
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