Shares

1. “If you’re smart, you don’t need a lot of money. And if you’re dumb, no amount of money is going to help you.”

If you’re smart you will understand the power of compounding interest. You will know the difference between a company that has a durable competitive advantage and one that doesn’t. And you will know how to value a company to determine if it is overpriced or underpriced. With that knowledge, you can take even a small sum of money and grow it exponentially to be worth millions of dollars. But if you’re dumb, even if you start with millions, eventually you are going to lose it all.

2. “The important thing is to know what you know and know what you don’t know.”

The secret behind Buffett’s incredible success is not an incredible intellect or being the all-knowing oracle of Omaha. In fact, it’s just the opposite. It’s actually about knowing what he doesn’t know. This stops Buffett from making investment decisions he isn’t qualified to make. An accountant would be inviting folly if he tried to play doctor.

Buffett feels the same way about investing. There are certain companies he has no idea how to value, and as a result he stays away from them. Then there are companies that he understands and feels very qualified to value – these are the ones that have made him super rich.

Buffett refers to this world of businesses that he understands well enough to value as his “circle of competence”– which means he is confident in his ability to value them. If he can confidently value companies, he can confidently tell if the sharemarket is undervaluing them or overvaluing them.

For Buffett, being able to spot when the market is undervaluing a company shows him where the big money is.

3. “Don’t save what is left after spending; spend what is left after saving.”

One gets rich by getting their money to work for them, but that won’t happen unless they first have money saved up to make that initial investment. For most people, the first money they have to invest comes from saving a percentage of what they earn from a job.

In Buffett’s teenage days, he was obsessed with saving money from the various little businesses he ran. And with his obsession for saving money came an aversion to spending it.

Buffett was so averse to spending money that he drove an old Volkswagen Beetle long after he had become a multimillionaire, and he still lives in the same house he paid $US31,500 for in 1957. In Buffett’s case, saving money was way more fun than spending money, unless, of course, he was buying stocks.

4. “My wealth has come from a combination of living in America, some lucky genes, and compound interest.”

Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it earns it … He who doesn’t, pays it.”

Buffett took this to heart early in his life and it truly has been the gift that kept on giving.

Here is how compounding interest works: $50,000 compounding at 10 per cent a year will be worth $55,000 after one year, $60,500 after two years, $66,550 after three years. After 10 years it will be worth $129,687. After 20 years it will be worth $336,375. After 30 years, $872,470. After 40 years, $2,262,962. After 50 years, $5,869,542.

In the first 10 years, we made $79,687 in interest on our $50,000 investment. But between the years 10 and 20 we made $206,688 in interest. And between years 20 to 30 we made $536,095 in interest. Between the years 30 and 40 we made $1,390,492 in interest. Between the years 40 and 50 we made $3,606,580 in interest. As the pot gets bigger, we make more and more in interest, which grows the pot even larger.

When Buffett took over Berkshire Hathaway, he stopped the company from paying a dividend so all the earnings would build up in Berkshire. Using his investment prowess, Buffett got Berkshire’s shareholders’ equity to compound at the phenomenal rate of 18.55 per cent a year for 59 years, growing shareholder’s equity from $US24.5 million in 1965 to approximately $US561.2 billion in 2024, for a total gain of 2,290,512 per cent.

Responding to the increase in shareholder’s equity, the market price for Berkshire’s stock, from 1965 to 2024, grew from $US12.50 a Class A share to $US632,000 a Class A share, which equates to an annual compounding growth rate of approximately 20.15 per cent.

Note: Our $50,000 investment compounding at a rate of 20.15 per cent a year, for 59 years, would be worth $2.52 billion in year 59, which is exactly how several of Buffett’s early investors ended up billionaires.

5. “From the standpoint of investments, you need two courses in a business school: one is how to value a business, and the other is how to think about sharemarket fluctuations.”

If Buffett was teaching a course in business school on how to value a business, he would teach students that there are basically two kinds of businesses.

(1) Businesses that sell commodity-type products, which have lots of price competition, low profit margins, low returns on equity, and volatile net earnings. These are the companies you don’t want to own.

(2) Exceptional businesses, which have some kind of durable competitive advantage, as evidenced by little price competition, high profit margins, high returns on equity, consistent earnings, and are buying back their shares. These are the right companies to own, and once identified, Buffett would explain to the students how to tell if they are selling at a price that makes business sense to buy them.

Buffett’s course on sharemarket fluctuations would provide a historical study of what market forces create buying opportunities. He would teach the students the history of events and forces that dramatically affect stock prices, what drives them from insane highs to depressing lows, and how these events can affect the share prices of companies with a durable competitive advantage and in the process create investment opportunities.

6. “You don’t want to be a no-emotion person in all of your life, but you definitely want to be a no-emotion person in making an investment or business decision.”

Buffett’s investment decisions – after weighing the economics of the business and the price he is paying – are based solely on whether or not he believes he is getting good value for his money. He’s very cold about it. In his early days, if he had a position that was making him money, even if he loved the company, if something better came along, he would sell it in a nanosecond and go with the new prospect.

He bought and sold his favourite Capital Cities Communications several times before he settled into a long-term position with it. This is the reason Buffett doesn’t react with fear in a stock market panic. His lack of emotion enables him to see long-term value and buy when everyone else is running for the fire escape. It’s also why he doesn’t get caught up in the euphoria of a bull market and end up paying insane prices for businesses.

7. “The most important item over time in valuation is obviously interest rates. If interest rates are destined to be at very low levels … it makes any stream of earnings from investments worth more money.”

Let’s say that Company A constantly produces earnings of $10 million a year. In a world of 10 per cent interest rates, we would have to invest $100 million in bonds that were paying 10 per cent to earn $10 million a year. Buffett would argue that Company A is worth $100 million relative to a 10 per cent interest rate. ($100 million × 10 per cent = $10 million.) Now, let’s say interest rates dropped to 2 per cent. We would have to invest $500 million in bonds paying 2 per cent to earn $10 million a year. ($500 million × 2 per cent = $10 million.) Buffett would argue that Company A’s earnings of $10 million a year are now worth $500 million relative to the 2 per cent interest rate.

The same inverse relationship also exists when discounting the future cash flows of a business to present value. The higher the discount rate, the lower the present value. The lower the discount rate, the higher the present value. So, a payment of $10 million a year for 10 years, discounted to present value, using a rate of 10 per cent, would have a present value of $61.3 million. But if we used a 2 per cent discount rate, a payment of $10 million a year for 10 years would have a present value of $89.4 million.

When interest rates drop, the relative value of what businesses earn goes up – and eventually, stock prices will follow upward as well. But when interest rates go up, the relative value of what businesses earn goes down – and stock prices will eventually go down as well.

8. “Obviously, profits are worth a whole lot more if the government bond yield is 1 per cent than they’re worth if the government bond yield is 5 per cent.”

For Buffett, all investment valuations are invariably linked to interest rates. If you owned a share of Apple stock and it earned $6.43 a share in 2023, you would need $128 invested in a 5 per cent government bond to yield you $6.43. But in a world of 1 per cent government bonds, you would need $643 invested in 1 per cent government bonds to yield $6.43. So as interest rates go down, stock prices “tend” to go up. And if interest rates go up, stock prices “tend” to go down.

Why government bonds? If they are United States Treasury bonds, they are thought of as being risk-free of default. In 2024, 10-year US Treasury bonds traded at 4.3 per cent, which gave Apple’s $6.43-a-share-earnings a relative value of $149 a share, against Apple shares reaching an all-time trading high in 2024 of $225 a share, which was 66 per cent above its relative value of $149 a share.

Buffett’s response to this overvaluation was to start selling his holdings in Apple. Even the best of companies can become overvalued – and when they do, Buffett will often cut his position.

9. “We do like having a lot of money to be able to operate very fast and very big. We know we won’t get those opportunities frequently … In the next 20 or 30 years there’ll be two or three times when it’ll be raining gold and all you have to do is go outside. But we don’t know when they will happen. And we have a lot of money to commit.”

Charlie Munger used to put it like this: “You have to be very patient. You have to wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.”

This is not the investment strategy of any fund manager in the world. Hold billions in cash and wait for the world to fall apart. But it is true – every 10 years or so, the financial world does fall apart and stock prices tank across the board. It happened in 2000 when the internet bubble burst, it happened in 2008 to 2009 when Wall Street imploded with the mortgage-backed bonds, it happened in 2020 with the COVID shutdown, and it will happen again and again.

And when it happens, stock prices will collapse, and the banks of the world will do what they always do, which is print tons of cash to pull us out of it, which will ultimately be bullish for stock prices. The hedge funds, mutual funds, and investment trusts of the world can’t play Buffett’s waiting game, they can’t sit on cash waiting for the mega opportunity. But Buffett can. And so can you!

10. “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

Buffett often talks about temperament. He means having the patience to wait for the right opportunity. By his own admission, he has sometimes sat waiting patiently for several years for the right investment opportunity to show up. And when it finally shows up, he takes full advantage and buys big.

Back in the 1980s, Buffett spent $US1.3 billion on Coca-Cola stock – which, today in 2024, is worth approximately $US24.4 billion. In the 1990s, he spent $US1.4 billion on American Express shares, which are now worth approximately $US32.4 billion. In the 2000s he bought $US14 billion worth of Bank of America stock, which was worth approximately $US35.1 billion in 2024 when he started thinning his position. In the 2010s, he spent $US31 billion for his Apple shares – which in the beginning of 2024 were worth a whopping $US176.8 billion before he started selling his position.

Invest big and win big if you follow in Buffett’s footsteps and buy shares in a company with a durable competitive advantage, and you buy it at a price that makes sense from a business perspective.

11. “There are a lot of businesses I wouldn’t buy even if I thought the management was the most wonderful in the world because they are simply in the wrong business.”

This goes back to something Buffett said in the 1990s: “When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”

Some businesses have inherent underlying economics that are so bad that even the best managers in the world can’t improve upon them. These are usually companies that sell a commodity-type product or service in which there is a lot of price competition, that historically sees a repetitive cycle of boom and bust. In the boom years demand outstrips supplies, creating huge profit margins, but in the bust years, low demand kills their profit margins, and their fixed costs end up killing them.

You can easily identify these businesses by an erratic earnings history – losses some years, very profitable in other years. They never buy back their shares, and usually carry a large amount of debt. All of which tells you it’s the wrong business to own – no matter what the selling price is.

The New Tao of Warren Buffet by Mary Buffett and David Clark, is published by Simon & Schuster.