Think Like Warren Buffett

Think Like Warren Buffett








by Glenn Curtis
Sunday, November 1, 2009
provided by
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in 1999, Robert G. Hagstrom wrote a book about the legendary investor
Warren Buffett, entitled "The Warren Buffett Portfolio". What's so
great about the book, and what makes it different from the countless
other books and articles written about the "Oracle of Omaha" is that it
offers the reader valuable insight into how Buffett actually thinks
about investments. In other words, the book delves into the
psychological mindset that has made Buffett so fabulously wealthy. (For
more on Warren Buffett and his current holdings, check out Coattail
Investor.)

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Although
investors could benefit from reading the entire book, we've selected a
bite-sized sampling of the tips and suggestions regarding the investor
mindset and ways that an investor can improve their stock selection
that will help you get inside Buffett's head.

1. Think of Stocks as a BusinessMany
investors think of stocks and the stock market in general as nothing
more than little pieces of paper being traded back and forth among
investors, which might help prevent investors from becoming too
emotional over a given position but it doesn't necessarily allow them
to make the best possible investment decisions.


That's why Buffett has stated he believes stockholders should think of
themselves as "part owners" of the business in which they are
investing. By thinking that way, both Hagstrom and Buffett argue that
investors will tend to avoid making off-the-cuff investment decisions,
and become more focused on the longer term. Furthermore, longer-term
"owners" also tend to analyze situations in greater detail and then put
a great eal of thought into buy and sell decisions. Hagstrom says this
increased thought and analysis tends to lead to improved investment
returns.

2. Increase the Size of Your Investment

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While
it rarely - if ever - makes sense for investors to "put all of their
eggs in one basket," putting all your eggs in too many baskets may not
be a good thing either. Buffett contends that over-diversification can
hamper returns as much as a lack of diversification. That's why he
doesn't invest in mutual funds. It's also why he prefers to make
significant investments in just a handful of companies.


Buffett is a firm believer that an investor must first do his or her
homework before investing in any security. But after that due diligence
process is completed, an investor should feel comfortable enough to
dedicate a sizable portion of assets to that stock. They should also
feel comfortable in winnowing down their overall investment portfolio
to a handful of good companies with excellent growth prospects.


Buffett's stance on taking time to properly allocate your funds is
furthered with his comment that it's not just about the best company,
but how you feel about the company. If the best business you own
presents the least financial risk and has the most favorable long-term
prospects, why would you put money into your 20th favorite business
rather than add money to the top choices?

3. Reduce Portfolio TurnoverRapidly
trading in and out of stocks can potentially make an individual a lot
of money, but according to Buffett this trader is actually hampering
his or her investment returns. That's because portfolio turnover
increases the amount of taxes that must be paid on capital gains
and boosts the total amount of commission dollars that must be paid in
a given year.

The "Oracle"
contends that what makes sense in business also makes sense in stocks:
An investor should ordinarily hold a small piece of an outstanding
business with the same tenacity that an owner would exhibit if he owned
all of that business.


Investors must think long term. By having that mindset, they can avoid
paying huge commission fees and lofty short-term capital gains taxes.
They'll also be more apt to ride out any short-term fluctuations in the
business, and to ultimately reap the rewards of increased earnings
and/or dividends over time.

4. Develop Alternative BenchmarksWhile
stock prices may be the ultimate barometer of the success or failure of
a given investment choice, Buffett does not focus on this metric.
Instead, he analyzes and pores over the underlying economics of a given
business or group of businesses. If a company is doing what it takes to
grow itself on a profitable basis, then the share price will ultimately
take care of itself.


Successful investors must look at the companies they own and study
their true earnings potential. If the fundamentals are solid and the
company is enhancing shareholder value by generating
consistent bottom-line growth, the share price, in the long term,
should reflect that.

5. Learn to Think in ProbabilitiesBridge
is a card game in which the most successful players are able to judge
mathematical probabilities to beat their opponents. Perhaps not
surprisingly, Buffett loves and actively plays the game, and he takes
the strategies beyond the game into the investing world.


Buffett suggests that investors focus on the economics of the companies
they own (in other words the underlying businesses), and then try to
weigh the probability that certain events will or will not transpire,
much like a Bridge player checking the probabilities of his opponents'
hands. He adds that by focusing on the economic aspect of the equation
and not the stock price, an investor will be more accurate in his or
her ability to judge probability.


Thinking in probabilities has its advantages. For example, an investor
that ponders the probability that a company will report a certain rate
of earnings growth over a period of five or 10 years is much more apt
to ride out short-term fluctuations in the share price. By extension,
this means that his investment returns are likely to be superior and
that he will also realize fewer transaction and/or capital gains costs.

6. Recognize the Psychological Aspects of InvestingVery
simply, this means that individuals must understand that there is a
psychological mindset that the successful investor tends to have. More
specifically, the successful investor will focus on probabilities and
economic issues and let decisions be ruled by rational, as opposed to
emotional, thinking.

More than
anything, investors' own emotions can be their worst enemy. Buffett
contends that the key to overcoming emotions is being able to "retain
your belief in the real fundamentals of the business and to not get too
concerned about the stock market."


Investors should realize that there is a certain psychological mindset
that they should have if they want to be successful and try to
implement that mindset.

7. Ignore Market ForecastsThere
is an old saying that the Dow "climbs a wall of worry". In other words,
in spite of the negativity in the marketplace, and those who
perpetually contend that a recession is "just around the corner", the
markets have fared quite well over time. Therefore, doomsayers should
be ignored.

On the other side
of the coin, there are just as many eternal optimists who argue
that the stock market is headed perpetually higher. These should be
ignored as well.

In all this
confusion, Buffett suggests that investors should focus their efforts
of isolating and investing in shares that are not currently being
accurately valued by the market. The logic here is that as the stock
market begins to realize the company's intrinsic value(through higher
prices and greater demand), the investor will stand to make a lot of
money.

8. Wait for the Fat PitchHagstrom's
book uses the model of legendary baseball player Ted Williams as an
example of a wise investor. Williams would wait for a specific pitch
(in an area of the plate where he knew he had a high probability of
making contact with the ball) before swinging. It is said that this
discipline enabled Williams to have a higher lifetime batting average
than the average player.


Buffett, in the same way, suggests that all investors act as if they
owned a lifetime decision card with only 20 investment choice punches
in it. The logic is that this should prevent them from making mediocre
investment choices and hopefully, by extension, enhance the overall
returns of their respective portfolios.

Bottom Line"The
Warren Buffett Portfolio" is a timeless book that offers valuable
insight into the psychological mindset of the legendary investor Warren
Buffett. Of course, if learning how to invest like Warren Buffett were
as easy as reading a book, everyone would be rich! But if you take that
time and effort to implement some of Buffett's proven strategies, you
could be on your way to better stock selection and greater returns.

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