How to Invest Like Warren Buffett

| October 15, 2017

Everyone wants to be known as a smart investor. But picking the right companies to back is usually one part knowledge, one part focus, and one part luck. Let’s examine the investing styles of several wealthy individuals for clues you might use. Each year, thousands of Warren Buffett fans and shareholders in his Berkshire Hathaway empire descend on Omaha, Nebraska, hoping to hear some pearls of wisdom from a man called “The Oracle” and considered one of the world’s greatest investors. Buffett, the king of value investing, is the chairman of the fourth largest public company in the world. His holding company has stakes in GEICO, American Express, Coca-Cola, Wells Fargo, IBM, and other huge brands. Berkshire Class A shares go for more than $250,000 on the New York Stock Exchange, the highest share price of any stock. Buffett’s personal fortune is estimated at $60 billion.

Given his financial acumen, you would expect Buffett to place a high value on intelligence when it comes to picking stocks. Instead, he once said, “If you have more than 120 or 130 I.Q. points, you can afford to give the rest away. You don’t need extraordinary intelligence to succeed as an investor.” Buffett is a modest man, but he lives his values. In fact, he once advised his wife to invest in index funds upon his demise. Yet he didn’t get to such lofty heights by being afraid to make a move. Instead, he follows a very specific pattern for his investments. While he has made his share of mistakes, his overall track record is a great one to emulate if you want to get rich.

THE BUFFETT METHOD

Buffett’s investments must meet several criteria. He looks for consistent earning power, good return on equity, capable management, and sensible price in shares. Buffett also looks for companies that have a good profit margin, especially if they are growing. And he considers whether the products sold by the company are unique in their field.

What breaks Buffett away from the pack is his uncanny ability to see a company’s true worth apart from its immediate numbers and his level of commitment once he invests. Buffett buys companies whose shares are lagging, and then holds those shares for extended periods of time. His outlook is long-term, and his belief system is that, eventually, the company will deliver on its promise.

His methods mean he’s investing primarily in established companies. Buffett admits he missed out on the internet boom because of that approach, and any innovation like blockchain or cryptocurrency is likely something he frowned upon. But go argue with the results.

RICHARD BRANSON’S VISION

While Buffett’s investing approach may be seen as stodgy, entrepreneur and fellow billionaire Richard Branson tackles investing in an entirely different way. The flamboyant founder of the Virgin brand is a true impact investor, looking for companies that will change the world and focusing on startups rather than established businesses. It’s not surprising, given that he started his career growing a tiny magazine into an empire that spans entertainment, airlines, and space ventures.

Branson says he loves “original products that make a positive difference in people’s lives and services that shake-up markets. Investing in these exciting startups and giving them the funds they need to grow into companies that deliver on their disruptive potential is essential.”

As such, when Branson filters funding requests, he looks for those factors. Branson says if you’re looking for help, you better answer an emphatic “yes” to these five questions:

1) Does your company offer a smart, simple solution that improves customers’ lives?

2) Is your company’s use of technology disruptive?

3) Does your company offer customers greater choice and better access?

4) Does your company’s product or service encourage customers to share their work or experiences?

5) Does your company care enough about people and the planet to use business as a force for good?

THE THIRD PATH

Depending on what survey you look at, Bill Gates is either the richest man in America or in the top three. Where he places is often a matter of timing on his investments, as some go up, some go down.

Surprisingly, Gates doesn’t rely heavily on his substantial share of Microsoft holdings to get to his reported $66 billion net worth (the stock represents just 20 percent of his portfolio).  Gates did what millions of other Americans do when they buy mutual funds – he let someone else manage the assets.

Gates relies on an investment firm he created called Cascade Investment LLC, managed out of Kirkland, Washington, near Microsoft headquarters. Gates hired Michael Larson of Cascade back in 1993 to oversee his money, just as millions of citizens do when they invest in a firm offering mutual funds. Gates started Cascade when he was worth only $5 billion. Since then, he’s racked up annual returns of 11 percent. Gates is somewhat akin to Buffett in his eclectic but value-oriented approach, and he’s not limited to technology investments. His recent portfolio includes shares in Republic Services, which operates 334 trash collection companies, 191 landfills, and 74 recycling operations. He’s also invested in AutoNation, which operates 258 car franchises, and Ecolab, a cleaning supply company. And he has a stake in the Four Seasons Hotel chain, no doubt because he’s been a frequent customer.

Gates is also involved in the self-created BGc3 (for Bill Gates Catalyst 3), a think tank and venture capital firm dedicated to scientific and technological services, industrial research, and combatting poverty; Corbis, a digital image licensor; nuclear reactor company TerraPower; and Research Gate, a social networking site for scientists and researchers. He also owns a 66,000 square-foot home on Lake Washington (nicknamed Xanadu 2.0), a private island in Central America, and a horse ranch in Florida.

It’s a diversified portfolio, and certainly Gates has some input. But he’s largely focused on ways to help Microsoft and humanity, through his charitable organization, leaving investment choices to others.

ACADEMIC RESEARCH BACKS BRAINS

While Buffett is older and largely risk-averse in his holdings, Branson is outgoing and looking to the future, and Gates apparently favors tangible and practical items, they all have one thing in common: smart people inevitably do better on investments than those without a high IQ, according to research studies. But being too smart also has its drawbacks.

In several joint articles, researchers from UCLA, the University of Chicago and Aalto University of Finland concluded that people with higher IQ’s tend to participate in the stock market more often, hold more diversified portfolios, and earn higher risk-adjusted returns than those with lower a IQ.

But having a high IQ can also dampen returns. That’s because those highly intelligent people are overly cautious.

In a study of Mensa members (those with an IQ in the top two percent) check their investment club managed a mere 2.5 percent annual return. The S&P 500 averaged 15.3 percent. So, here’s what we can learn from the investment strategies of three of the smartest investors over the last two centuries: do your homework, look for hidden value, determine whether a company will have an impact going into the future, and closely monitor your holdings to make sure the company is staying on track.

Oh, yes – and have a few million dollars ready to put down. That one rule makes everything easier.