If you have been in the investing world for any period of time you are undoubtedly familiar with the man who many label as the greatest investor of all time – Warren Buffett. For those who require a little background, Warren Buffett is the self-made billionaire who built an empire through an unwavering focus on the simplest tenets of value investing. For nearly 50 years, Warren Buffett has earned prominence as the genius behind Berkshire Hathaway and has generated its investors a staggering average compound rate of return of 21.6% per year (1965 – 2014), compared to the S&P 500 which has produced an average return of 9.9% over that period (less than half of Buffett’s return).

Many detractors to Buffet’s value-investment style claim that his success cannot be replicated by individual investors. Often cited is Buffet’s solid reputation as a capital allocator and the deep investigative resources of his investment company Berkshire Hathaway. Undoubtedly Warren Buffet is a genius and we would not expect that any but the most gifted individuals would ever be able to replicate his success in its entirety. Nevertheless we can easily dispel the myth that reputation and resources were the ingredients to his success. Going back to 1956, before Buffet was a world famous billionaire (or millionaire for that matter), he was a relatively unknown man who operating his first investment partnerships out of an office in his bedroom. The limited partnerships were started with his own capital and a few some contributions from family and friends. He had no world renowned reputation, no staff of highly-skilled MBAs, and no special resources outside of himself. Buffet recognized the most basic and useful facets of valuing investing and applied the concepts to generate great success. Throughout the years he has participated in numerous interviews and writes a letter to his shareholders on an annual basis. Through these small snippets of information the general public has been able to gain some insight into how Buffet views the investing world. The following are a couple of his most well read quotes with a little insight into how anyone can use them to better far more intelligent investors. 

“Price is what you pay. Value is what you get.”

Separating value from price is the most fundamental tenet of Buffet’s investment strategy. Pretty much everybody has a basic understanding of what the word “value” means but unfortunately this is rarely applied to investment decisions. There is a saying that most investors spend more time researching the purchase of their television set than they do their investments. This is largely due to a lack of knowledge and valuation skills which is why many investors rely on stock price movements as a signal of investment quality. When Buffet starts researching a stock he says he intentionally will not look at the market price. Instead he starts with valuing the underlying business as if it were a private company. He looks at the cash flow…he determines whether or not the business model is sustainable and if the earnings are being inflated by too much leverage (debt). Buffet then determines what we would pay for the actual company without any consideration for the fact that it is publicly-listed. If after making this determination the current stock price is significantly below his measurement of intrinsic value then he may move forward and make his purchase.

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

Don’t worry…nobody is planning on closing the market for the next five years. What Buffet is saying is that he doesn’t buy a stock with the intention of following the short-term market fluctuations and selling in and out on whims. When Buffet buys a stock, he is buying an ownership interest in an underlying company. This is largely the reason that Buffet is so successful. Rather than wasting his energy following day-to-day market oscillations (as many investors do), he focuses on the business that he has acquired and gauges success based on sustainable generation and growth of the underlying cash flow. Many businesses generate returns for their shareholders through the distribution of cash flow in the form of dividends. A successful company will also be able to grow their dividends over time. Eventually success is recognized in the markets. Although it can take time for value to be realized, there are very few examples of companies that produce strong and growing cash flow over time without either this eventually being recognized in the share price or by an independent buyer looking to acquire the company.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

We are often asked by clients whether or not we utilize a timing strategy to move in and out of the markets with changes in the business cycle. Although market timing may appear to be a sound investment strategy, in practice, the results investors generate are far from astonishing. “Hindsight is 20-20, while foresight is legally blind”. The truth is that there are no

magical indicators that will tell you (with consistent success) when to buy and sell stocks. If there were then we would expect to see at least one of these magical market timers (or technical analysts) on Forbes list of the world’s richest people (but we have not). Buffet as well does not subscribe to the traditional idea of market timing. He has however been able to apply his value investment methodology to creating a somewhat modified version of the strategy. If we take a step back to 2008 at the time of the stock market crash we will remember the fear that plagued the markets. Stock market prices dropped to levels not seen in over a decade causing private and professional investors to rush to the exits. Although fear was abundant and the outlook was grim, this was exactly the best time to be greedy with many very high-quality companies available for purchase at a fraction of their real value. If we go back to the summer of 2000, when the NASDAQ’s chart (along with the charts of many other exchanges) was nearly parabolic, investor optimism was high and greed pushed market valuations of internet stocks well beyond reasonable levels. This was undoubtedly a good time to be fearful. We would never suggest that you try and time the markets based on anyone’s assessment of market sentiment. This won’t produce any better results than any other market timing strategy. However, the next time market valuations have undergone expansion far beyond historical ranges, and experts are justifying the sentiment with the mantra “everything is different now”, you might want to consider separating yourself from the crowd and become a little more fearful. 

“Success in investing doesn’t correlate with I.Q….. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

This has got to be my favorite quote from Warren Buffet. It gives hope to every ordinary investor who believes that they cannot compete with the pros. While Buffet is commonly referred to as the “smartest man in the room”, he himself openly confesses that his skills outside of capital allocation are fairly limited. And within this skillet Buffet utilizes only the simplest and most basic techniques in investment analysis. There are no super computers systems, no Nobel Prize winning mathematicians, and certainly no new age strategies in the Berkshire Hathaway investment management office. The biggest asset (aside from their near $400 billion in capital) is their underlying philosophy that investment success is derived from purchasing high-quality, cash flow positive businesses at undervalued prices and holding those businesses over a long-term horizon. By controlling the emotions of fear and greed, individual investors can set themselves apart from the investment heard and create for themselves a very practical competitive advantage that the vast majority of people (including professionals) do not have. 

Disclaimer | 2015 KeyStone Financial Publishing Corp.

The 2nd part of the incredible behind the scenes look at the multi- billion dollar investment industry. The stories fund managers world-wide would rather you didn’t see!

“If you are serious about investing and building wealth the video documentary series ‘How To Win The Losers Game” is a must see. It’s excellent. 

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Paul Philip, Financial Wealth Builders Securities

Some important thoughts from Richard Russell who passed on Nov 21. Richard wrote Dow Theory Letters since 1958, the longest investment letter in the industry continuously written by the same person. When the internet became available his passion for writing exploded and he wrote his subscribers daily, always including personal comments or special treats like this one below.:

AH PERFECTION: Strange, but the most popular, the most widely-requested, and the most widely quoted piece I’ve ever written was not about the stock market — it was about business, and specifically about what I call the theoretical “ideal business.” I first published this piece in the early-1970s. I repeated it in Letter 881 and then again in Letter 982. I’ve added a few thoughts in each successive edition. But seldom does a month go by when I don’t get requests from subscribers or from some publication or corporation to republish “the ideal business.” So here it is again — with a few added comments.

I once asked a friend, a prominent New York corporate lawyer, “Dave, in all your years of experience, what was the single best business you’ve ever come across?” Without hesitation, Dave answered, “I have a client whose sole business is manufacturing a chemical that is critical in making synthetic rubber. This chemical is used in very small quantities in rubber manufacturing, but it is absolutely essential and can be used in only super-refined form. 

“My client is the only one who manufactures this chemical. He therefore owns a virtual monopoly since this chemical is extremely difficult to manufacture and not enough of it is used to warrant another company competing with him. Furthermore, since the rubber companies need only small quantities of this chemical, they don’t particularly care what they pay for it — as long as it meets their very demanding specifications. My client is a millionaire many times over, and his business is the best I’ve ever come across.” I was fascinated by the lawyer’s story, and I never forgot it.

When I was a young man and just out of college my father gave me a few words of advice. Dad had loads of experience; he had been

in the paper manufacturing business; he had been assistant to Mr. Sam Bloomingdale (of Bloomingdale’s Department store); he had been in construction (he was a civil engineer); and he was also an expert in real estate management. 

Here’s what my dad told me: “Richard, stay out of the retail business. The hours are too long, and you’re dealing with every darn variable under the sun. Stay out of real estate; when hard times arrive real estate comes to a dead stop and then it collapses. Furthermore, real estate is illiquid. When the collapse comes, you can’t unload. Get into manufacturing; make something people can use. And make something that you can sell to the world. But Richard, my boy, if you’re really serious about making money, get into the money business. It’s clean, you can use your brains, you can get rid of your inventory and your mistakes in 30 seconds, and your product, money, never goes out of fashion.” 

So much for my father’s wisdom (which was obviously tainted by the Great Depression). But Dad was a very wise man. For my own part, I’ve been in a number of businesses — from textile designing to advertising to book publishing to owning a night club to the investment advisory business.

It’s said that every business needs (1) a dreamer, (2) a businessman, and (3) a S.O.B. Well, I don’t know about number 3, but most successful businesses do have a number 3 or all too often they seem to have a combined number 2 and number 3. 

Bill Gates is known as “America’s richest man.” Bully for Billy. But do you know what Gates’ biggest coup was? When Gates was dealing with IBM, Big Blue needed an operating system for their computer. Gates didn’t have one, but he knew where to find one. A little outfit in Seattle had one. Gates bought the system for a mere $50,000 and presented it to IBM. That was the beginning of Microsoft’s rise to power. Lesson: It’s not enough to have the product, you have to know and understand your market. Gates didn’t have the product, but he knew the market — and he knew where to acquire the product. 

Apple had by far the best product in the Mac. But Apple made a monumental mistake. They refused to license ALL PC manufacturers to use the Mac operating system. If they had, Apple today could beMicrosoft, and Gates would still be trying to come out with something useful (the fact is Microsoft has been a follower and a great marketer, not an innovator). “Find a need and fill it,” runs the old adage. Maybe today they should change that to, “Dream up a need and fill it.” That’s what has happened in the world of computers. And it will happen again and again.

All right, let’s return to that wonderful world of perfection. I spent a lot of time and thought in working up the criteria for what I’ve termed the IDEAL BUSINESS. Now obviously, the ideal business doesn’t exist and probably never will. But if you’re about to start a business or join someone else’s business or if you want to buy a business, the following list may help you. The more of these criteria that you can apply to your new business or new job, the better off you’ll be.

(1) The ideal business sells the world, rather than a single neighborhood or even a single city or state. In other words, it has an unlimited global market (and today this is more important than ever, since world markets have now opened up to an extent unparalleled in my lifetime). By the way, how many times have you seen a retail store that has been doing well for years — then another bigger and better retail store moves nearby, and it’s kaput for the first store. 

(2) The ideal business offers a product which enjoys an “inelastic” demand. Inelastic refers to a product that people need or desire — almost regardless of price.

(3) The ideal business sells a product which cannot be easily substituted or copied. This means that the product is an original or at least it’s something that can be copyrighted or patented. 

(4) The ideal business has minimal labor requirements (the fewer personnel, the better). Today’s example of this is the much-talked about “virtual corporation.” The virtual corporation may consist of an office with three executives, where literally all manufacturing and services are farmed out to other companies.

(5) The ideal business enjoys low overhead. It does not need an expensive location; it does not need large amounts of electricity, advertising, legal advice, high-priced employees, large inventory, etc. 

(6) The ideal business does not require big cash outlays or major investments in equipment. In other words, it does not tie up your capital (incidentally, one of the major reasons for new-business failure is under-capitalization). 

(7) The ideal business enjoys cash billings. In other words, it does not tie up your capital with lengthy or complex credit terms.

(8) The ideal business is relatively free of all kinds of government and industry regulations and strictures (and if you’re now in your own business, you most definitely know what I mean with this one). 

(9) The ideal business is portable or easily moveable. This means that you can take your business (and yourself) anywhere you want — Nevada, Florida, Texas, Washington, S. Dakota (none have state income taxes) or hey, maybe even Monte Carlo or Switzerland or the south of France.

(10) Here’s a crucial one that’s often overlooked; the ideal business satisfies your intellectual (and often emotional) needs. There’s nothing like being fascinated with what you’re doing. When that happens, you’re not working, you’re having fun. 

(11) The ideal business leaves you with free time. In other words, it doesn’t require your labor and attention 12, 16 or 18 hours a day. 

(12) Super-important: the ideal business is one in which your income is not limited by your personal output (lawyers and doctors have this problem). No, in the ideal business you can sell 10,000 customers as easily as you sell one (publishing is an example). 

That’s it. If you use this list it may help you cut through a lot of nonsense and hypocrisy and wishes and dreams regarding what you are looking for in life and in your work. None of us own or work at the ideal business. But it’s helpful knowing what we’re looking for and dealing with. As a buddy of mine once put it, “I can’t lay an egg and I can’t cook, but I know what a great omelet looks like and tastes like.”

This is a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments. When we look at the statistics of what percentage of actively managed funds underperform, the are even more dire when survivorship bias is taken into account…. CLICK HERE to watch the video

The Evidence-Based Investor Video series is a service provided by Paul Philip and the team at Financial Wealth Builders Securities