Over the past couple of years, the market has been rather unpredictable. For example, who would have thought oil prices would collapse like they did, or that the market would plunge by nearly 10% during the first six weeks of 2016 only to make it all back and then some?
The point is that nobody knows what's next for the market. The S&P 500 index could plunge 20% this year, or it could reach new record highs just as easily. So the best course of action is to employ investment principles that work no matter what, like the four that have been used by Warren Buffett and his team to produce incredible returns at Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) through good times and bad.
Buffett's investment goals
When Warren Buffett wrote his 2008 letter to Berkshire Hathaway's shareholders, investors were justifiably nervous about what was going on in the economy. Banks were collapsing, the U.S. auto industry was on the brink of failure, and even rock-solid stocks like Berkshire were trading at levels not seen in years.
Buffett ensured investors that 2008 was just another bump in the road, and said that it's important to keep things in perspective -- especially during the tough times. He pointed out that during the 20th century, Americans' real standard of living had improved sevenfold, despite two huge wars, the Great Depression, a period of rapid inflation, and about a dozen other panics and recessions along the way.
He even went on to say that the economy would likely be in shambles for several years, but that there was no need to panic. Berkshire would simply continue to do what it does best by focusing on four specific goals that boost the company's long-term potential no matter what the market is doing this week, this month, or this year.
1. Maintain Berkshire's financial position: No matter what happens, Berkshire maintains modest to minimal debt levels, lots of liquidity, few near-term obligations, and lots of income streams. This allows the company to not only absorb any adverse market conditions, but to come out of the bad times even better off than it went in. In fact, during the 2008-2009 market turbulence, Berkshire was a provider of liquidity to the banking industry, and ended up with some pretty profitable investments as a result.
2. Widen the moats: A "wide economic moat" is a Buffett term that essentially means a durable competitive advantage that should allow a company to prosper in good times and bad for the foreseeable future, and that makes it relatively immune to competition. For example, Wal-Mart's wide moat consists of its size and distribution network, which allows it to sell goods at a lower price than any of its competitors. As Wal-Mart's global footprint continues to grow, its moat continues to widen.
3. Acquire and develop new and varied streams of earnings: Berkshire is always on the lookout for new acquisitions and investments, in good times and bad. During the financial crisis, for example, Berkshire acquired a new revenue stream in the form of Bank of America preferred stock, which came with warrants to buy shares cheaply down the road. Just recently, Berkshire made its biggest acquisition yet when it bought Precision Castparts. The point is that Berkshire is always looking to grow and diversify its revenue stream. While it's impossible for a company like Berkshire to grow its profits every single year, varied streams of earnings allow it to grow its profit potential every year without fail.
4. Focus on good management: I can't emphasize enough how much value Buffett places on good management. He literally believes that the right management team can add billions to a business's intrinsic value, while the wrong management can make an otherwise good company an undesirable investment. Therefore, the goal, no matter what the market is doing, is to always be on the lookout for outstanding managers and to nurture those who are already part of the organization.
How you can apply these goals to your own portfolio
While the most obvious way to benefit from these four investment goals in your portfolio would be to invest in Berkshire Hathaway, that's not really my point here (although Berkshire is one of my favorite stocks and makes up a large portion of my own portfolio).
Rather, the point is that these lessons can be modified slightly in order to apply them to your own investment strategy:
- Buy stocks with financial flexibility and low debt.
- Identify a durable competitive advantage before buying a stock.
- Don't worry about what the market is doing now -- always be on the lookout for opportunities.
- Investing in companies with shareholder-friendly management can make all the difference over the long run.
Successful implementation of these four goals has allowed Berkshire to increase its book value during 48 of the past 50 years. Although the stock price didn't increase in all 48 of these years, that wasn't the goal. Rather, the objective was to set the company up for long-term market-beating performance, an objective which was clearly achieved.
Matthew Frankel owns shares of Bank of America and Berkshire Hathaway (B Shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B Shares). The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.