How Warren Buffett Destroyed the Market

A few months ago, I laid out exactly how mutual fund manager Peter Lynch averaged 29% annual returns for more than a decade.

Due to popular demand, today I'm going to lay out exactly how Warren Buffett has destroyed the market for almost half a century. For the uninitiated, he has more than doubled the market's return. Put another way, if you invested $10,000 with him in 1965, you'd be sitting on tens of millions of dollars right now.

I've broken his success down to three basic principles.

Principle No. 1: There will always be opportunities, but those opportunities will change. Be flexible.
Buffett was just a pup investor in the 1950s and 1960s. He didn't have billions to invest, but he created certain advantages for himself.

Back then, information for individual investors was hard to come by. There was no Yahoo! Finance around to get financials in a jiffy, no tweeting CEOs, and no 24-hour news cycle. And that was an opportunity for Buffett. 

He'd literally do the legwork by making trips to Moody's and Standard & Poor's to read old analyst reports, to the Securities and Exchange Commission to read filings, and to company headquarters to talk with management. If you don't think that's incredible, realize that most investors today haven't taken the minute to send in a question to a company's investor relations department ... much less show up on its doorstep.

In those days, he'd invest in opportunities in small-cap companies, exploit some inefficiencies and arbitrages, and do the down-and-dirty, by-the-numbers value investing that his mentor Benjamin Graham preached. And he made excellent returns.

As he went further in his investing career, he diverged from Graham's teachings, partially under the influence of his partner Charlie Munger. He learned the value of buying great companies at good prices, rather than less adept companies at rock-bottom prices. This would serve him well as increased information availability made those early opportunities rarer.

Today, his holding company Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) has gotten so large that the small caps he used to enjoy buying are mere drops in the bucket. He has to be more patient as he waits for huge opportunities.

That's why he's known today for his megadeals. For buying multi-billion-dollar stakes in General Electric (NYSE: GE  ) and Goldman Sachs during their darkest hours. For buying a railroad with a bigger market capitalization than Nike. And for being paid handsome, above-market premiums for insuring against a portfolio of unlikely events.  

Buffett has "skated to where the puck is" his whole investing career.

Principle No. 2: There's no extra credit for activity
Roger Lowenstein, who wrote both a biography on Buffett (Buffett: The Making of an American Capitalist) and a chronicle of disastrous, short-term-thinking hedge fund Long-Term Capital Management (When Genius Failed), has some good perspective on both sides of the trading activity spectrum.

When he was asked in a recent Motley Fool interview to name the most underrated thing about Buffett, he responded: "The most underrated part of his success would be his independence of character, his ability to just not do what everyone else is doing, to stand apart from it ... just not to be affected by it and not swing at pitches he is not sure about."

Now, to be sure, Buffett is far from infallible. He doesn't see everything coming. For example, he didn't foresee the magnitude of the housing crisis. He was adding significantly to his positions in Wells Fargo (NYSE: WFC  ) and US Bancorp (NYSE: USB  ) in 2007 -- right before the fall of Bear Stearns and Lehman Brothers and subsequent bank bailouts. Also at the end of 2007, he owned 19% of Moody's -- one of the ratings agencies responsible for terribly overrating the quality of subprime loans and fueling the housing bubble. Heck, he even owned a homebuilder outright – manufactured-homes maker Clayton Homes.  

But here's what makes Buffett great. He avoided using the crazy derivative instruments the Wall Street banks, hedge funds, and insurers gloried in. Remember that Berkshire Hathaway, at its core, is an insurance company. It would have been very easy for Berkshire to get in on all the exotic stuff AIG (NYSE: AIG  ) got into. It didn't. Buffett also avoided the siren song of excessive leverage.

And then, while the market was in a panic, he didn't massively sell off his bank positions. No, he actually added to his position in Wells Fargo. 

Principle No. 3: You can't be Buffett
Well, for him, it was, "You can't be Ben Graham."

As we talked about in principle No. 1, Buffett had to evolve beyond the teachings of his mentor. Similarly, as tempting as it is, we can't blindly follow everything Buffett does.

One of the famous Buffett stories involves his collegiate days, when he supposedly read all his coursework the first week of the semester, then just breezed through the exams. Believe it or not, I've heard stories of lesser minds who have tried to imitate him. I'll let you guess at the results.  

We must pick and choose which Buffett actions we follow. For example, some of the deals he does aren't available to the public. It would be folly to buy into General Electric and Goldman Sachs just because he did. He got sweetheart deal terms on preferred shares and warrants that we don't get with the common shares.

Don't think this has always been the case, though. Back to Lowenstein for some color:

If you look at the stocks that made him, The Washington Post was selling at four times earnings; anybody could have bought it. Same thing, the ad companies, same thing Coca-Cola (NYSE: KO  ) back when he bought it in the eighties. Just on and on and on.

Even with the Internet now threatening the Post and all newspapers, Buffett bought into his position at such an opportune time (the 1970s) that it has gone up more than 50-fold. Similarly, Coke is up almost 10-fold. Price matters.

The takeaways
Buffett's an original. No investor will "be the next Buffett." But we can learn from him as we aspire to make our own fortunes.

Buffett learned and adapted throughout his lifetime, mastering the world of small-cap stocks and ratcheting up all the way to making huge acquisitions for one of the largest companies in the world. When he started investing, there were many more opportunities for information arbitrage -- i.e., profiting on information the rest of the market doesn't have access to. Today, it's more about parsing all the information readily available to us, and figuring out which pieces of data matter.

Buffett has been able to thrive throughout because he is, as Munger calls him, "a learning machine." That's something we should mimic.

But don't confuse "learning and adapting" with rapidly buying in and out of stocks, chasing the next new thing. Learning should be constant, but buying and selling should be measured and less frequent.

Fool on!

In this article, I've shown a top-level view of how Buffett has destroyed the market. For specific concepts he has used, check out Buffett's Top 10 Investing Secrets.

Anand Chokkavelu owns shares of Berkshire Hathaway and a poster of Warren Buffett. He may be kidding about the latter. Or not. Berkshire Hathaway, Coca-Cola, and Moody's are Motley Fool Inside Value recommendations. Berkshire Hathaway and Moody's are Motley Fool Stock Advisor picks. Coca-Cola is a Motley Fool Income Investor recommendation. Motley Fool Options has recommended a stock repair position on Moody's. The Fool owns shares of Berkshire Hathaway and Coca-Cola. The Fool has a disclosure policy.


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Comments from our Foolish Readers

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  • Report this Comment On July 22, 2010, at 3:05 PM, rfwiest wrote:

    You still don't have it right. You glorify Buffett as the all-time greatest investor, when, in fact, he is an under-achiever. Over the last decade his Bershire stock has under-performed the Dow by 27%. Actually, their records are identical, but holdrs of the Dow stocks would have earned 27% in dividends, while Berkshire pays zip.

    Call me at (916) 660-9897, and I'll tell you about some of the things ehich are in my book, such as the above about Buffett; and about the celebrated commodity trader who ripped off the public for $10 million; or the co-founder of a major electronics firm who stole $400 million from his fimr; or the major NYSE brokeraqge firm which pleased guilty to rigging the U.S. Treasure market and paid a $190 million fine; or the Vice Chairman of one of the giant regulatory agencies who helped his firm embezzle 82% of the assets of one of the public funds they managed; and a couple dozen more similar stories.

    The irony is that not one single person was ever arrested in any of these cases.

    Maybe you would also like to read the REAL reason why Madoff turned himself in.

    It's all in my book.

    Robert F. Wiest

  • Report this Comment On July 22, 2010, at 3:14 PM, TMFHousel wrote:

    "Over the last decade his Bershire stock has under-performed the Dow by 27%."

    I bet to differ. Over the past 10 years, BRK shares are up 122%; the Dow is down 3.4%.

  • Report this Comment On July 22, 2010, at 3:14 PM, TMFHousel wrote:

    Err, I beg* to differ.

  • Report this Comment On July 22, 2010, at 5:00 PM, holosys wrote:

    The $64 million dollar question is whether an investor who invested $10,000 in the Dow in 1965 would have been worth more than if he invested that money with Buffett?

  • Report this Comment On July 22, 2010, at 5:04 PM, Archvile wrote:

    I don't understand how this article relates to the title. How did, Buffett destroy the market?

  • Report this Comment On July 22, 2010, at 5:06 PM, ibitegirls wrote:

    what you smoking Robert Wiest? let me get some of that lmao

  • Report this Comment On July 22, 2010, at 5:11 PM, mtracy9 wrote:

    "Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50 percent a year on $1 million. No, I know I could. I guarantee that." --Warren Buffett

    http://shouldersofgiantsinvestor.com/

  • Report this Comment On July 22, 2010, at 6:10 PM, ddepperman wrote:

    Ahem.. I remember reading one foolish article that recommended Moody's back then. I thought you quaint indeed. I was reading the daily pfennig and john mauldin and others and they got it on the head way before you did! They knew Moody was screwy. Do Due Diligence.

    Another thing you don't mention about Buffett is that he needed a source of investment capital. I can't do this but he did-->he bought Geico, insurance cos didn't pay taxes on some part of the float. So he had tax free bucks to invest. Now where's a cheap insurance co to invest in anyway, just when you need one?

    And I think--though I may be wrong--that Buffett was early on doing this: your quote, "As he went further in his investing career, he diverged from Graham's teachings, partially under the influence of his partner Charlie Munger. He learned the value of buying great companies at good prices, rather than less adept companies at rock-bottom prices." C'mon, he was already doing this early on way way before Charlie Munger appeared on the scene. Munger is a Johnny-come-lately. A good one too. And finally, when Buffett dies, the stock will plummet and not ever fully recover. So keep up on the news. Buffett is gettin' fat I see. His heart can't like that.

  • Report this Comment On July 22, 2010, at 6:11 PM, RichardRussel wrote:

    I think he means as in "beaten" the market

  • Report this Comment On July 22, 2010, at 9:27 PM, TMFBomb wrote:

    @Archvile and RichardRussell,

    Yup, it destroyed means "beaten" in this case.

    -Anand

  • Report this Comment On July 22, 2010, at 11:03 PM, susan400 wrote:

    Robert F. Wiest-- you don't own BRK.

    We each get waht we ask for.

  • Report this Comment On July 23, 2010, at 1:40 AM, Glycomix wrote:

    Buffett earned $34 Billion from 1955 to 1995 by investing in companies where he would make at least 20% on each trade. Hathaway still uses the methods that he pioneered.

    Mary Buffett, his ex daughter-in-law, discussed stocks with him as one of the family for 9 years, and mentioned a portion of his strategy in a nutshell is as follows:

    1. Try to shelter yourself from taxes as much as you can.

    2. Don't buy growth stocks because they often burst, and don't do momentum trades because they'll bite you even if you're good.

    3. Screen for stocks with > 15% return on equity and return on assets, who haven't had financial problems in 10 years. [You can use a combination of increase in stock price and buy-back as return on investment]. Buffett often bought stocks that wouldn't be impressive in performance, but worked well when you add up all of the unnoticed increase in value. He always wanted 20% or more return on his investment.

    4. Buy stocks with a huge competitive advantage whose underlying business is going to make money no matter what happens: They gave teh example of Coca-cola. They'll make money no matter what happens and without much outlay of funds because people all over the world prefer their drink.

    In the competitive advantage, It's difficult to compete because everyone goes to this person, or there's too much difficulty in trying to become competitive. However, it's hard to figure out who is likely to have competitive advantages. In Buffett's time it took at least 15 years for a competivite advantage to disappear. Now, it doesn't take any time.

    5. Buy stocks that are highly undervalued.

    Buffett bought an insulation company that was being sued due to lawsuits over asbestos insulation. The portion of the company that had made asbestos insulation went bankrupt. However, the rest of the company did well. Buffett sold that company at a 300% profit.

    She said in her 2003 book that TD Ameritrade will allow anyone who has $100,000 in an account to trade for free. I don't know if that's still true. However, if it is it's still true, then that's a good deal.

    All of the above strategies are additive. Buy a stock with a competitive advantage that's highly undervalued is the best choice. However, That's hard to do.

    There are other strategies that she mentioned, but they can't be put in a nutshell.

  • Report this Comment On July 23, 2010, at 4:08 AM, sydisquid wrote:

    the quote is "skate to where the puck will be", not skate to where it is. The idea is being able to anticipate where the action will be. If you go to where it is now, where the puck is, you'll get there too late.

  • Report this Comment On July 23, 2010, at 12:31 PM, shivy1 wrote:

    Just some advice to Anand, be careful on your titles, next time just say beaten. Great article, though everything you said has been repeated alot.

    -Tony

  • Report this Comment On July 25, 2010, at 9:55 PM, Chowboy100 wrote:

    Shut your jibba jabba Glycomix!

    You make me mad sucker!

    What the.........!?

    Get a life man.

  • Report this Comment On July 26, 2010, at 11:29 AM, prettymeadow wrote:

    What we need to do is to go back to the pre Reagan era tax rates. To a time in the 50's and 60's where you didn't need 3 jobs to make it. The wealthy were still wealthy but instead on draining their businesses, they reinvested in them to make them grow. Instead of shipping jobs overseas we had a stable or even growing middle class. Back then the rop tax rates were 91% and America was booming. This trickle down economics doesn't work and this 30 yr experiment needs to end. The gap between the rich and poor is now a giant chasm and there is even a chasm between the mearly wealthy and the uber wealthy. This madness needs to end. We need the tax revenue to pay for the infrastructure projects that have been put on hold since the Reagan era. Our electrical grid needs a major overhaul. Our bridges and roads need major repair. The only way to do the things that need to be done is to raise taxes on the very wealthy. Don;t worry about the "lost jobs" that you think will happen or that the wealthy will relocate else where. (Let them try living in Somalia or any other tax haven without getting killed) If they want Americans to buy their goods and services they will likely stay here. Besides most of thier money is made with dividends which is taxed at a much lower rate than regular income.

    Warren Buffet has even commented on the fact that he pays less in taxes than his secretary. That needs to change. He can afford to pay a million times more than his secretary pays in taxes. Have you been paying attention to what corporations actually pay in taxes? It's not much if anything at all. for instance Exxon/mobile paid $0 that is ZERO DOLLARS in federal taxes Dow paid $4.00 dollars in federal taxes. I personally paid 720 times more in taxes than Dow chemical but I'm sure I didn't make more than a mere fraction of 1% of the income Dow chemical made. Especially since Dow made $12.5 Billion dollars last year.which 390,000+ times more than I made.

    The tax rates are unfair to the poor and middle class because we don't get land and more $ forked over to us in the amounts large corporations and wealthy individuals do. I would definates like to see a return to the tax rates of the the 1950's and 60's.

  • Report this Comment On July 26, 2010, at 6:04 PM, dollarfor40cents wrote:

    @prettymeadow, that's all and nice until you are on the other side of the coin. Until you watch the fruits of your blood sweat and tears being stolen and redistributed. You can only rob the producers for so long until a tipping point is reached, they take money elseware.

  • Report this Comment On July 27, 2010, at 3:13 PM, allied35 wrote:

    Wow, it's amazing how some Americans like Glycomix blame the the entirety of the US's problems on Obama and the Democrats; as if Bush didn't cut taxes and then spend like a crack-head with a stolen wallet!

    "OBama and congress sold this priceless American competitive advantage to Fiat for worthless Italian Lira." -Glycomix

    Haha, Lira huh?

    Here's a little history lesson:

    http://www.pbs.org/wgbh/pages/frontline/tentrillion/view/

  • Report this Comment On July 29, 2010, at 4:18 PM, aviator7 wrote:

    @allied 35. What did you expect? It's PBS! (taxpayer funded).

  • Report this Comment On July 29, 2010, at 8:01 PM, Sleddawg63 wrote:

    Sorry the 50's and 60's are never coming back. Thomas Friedman's "The World Is Flat" lays this out in plain terms. If you are unskilled then you are basically doomed. In Canada, the City of Windsor just lost two auto parts plants in two days...one from bailed out GM and the other from non-bailout Ford. This is a prime example of a flat world. Somewhere there is a non union labourer who could only hope to get health care doing the job for pennies on the dollar.

    Even more startling is that our home town newspaper outsources it's creative ad work to India. Yep, India. If a small town paper is doing that, who knows what the big boys are doing.

    We cannot hope to turn back the clock, we can only anticipate that it will keep ticking forward and adjust ourselves accordingly.

  • Report this Comment On July 30, 2010, at 11:52 PM, weihou258 wrote:

    do I subscribe to a wrong political service ?

  • Report this Comment On July 31, 2010, at 4:04 AM, alanruud101 wrote:

    Regarding the title of this article: The only reason I clicked on this (and probably most everyone else), was because I was thinking "How in the world did Buffett DESTROY the market". GENIUS title...!

  • Report this Comment On July 31, 2010, at 7:23 PM, TMFBomb wrote:

    @alanruud101,

    Hopefully you came for the title but stayed for the content... :)

    -Anand

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