There is one thing most investors agree on: Warren Buffett is hands-down the greatest investor the world has ever known. Today, Buffett is the world's third-wealthiest person, according to Forbes' list of billionaires. Forbes pegs Buffett's net worth at $68.5 billion. That figure is up $8.5 billion from last year, propelled by his Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) stock, which has hit all-time highs.
In Buffett's story, we find a lighthouse for investors looking for a strategy that actually works to make money in stocks. But we need a summary of his journey to building a fortune to fully appreciate his principles for building wealth in the stock market.
A bit of privilege and a lot of genius
Born in 1930 to stockbroker-turned-Congressman Howard Buffett, Warren may have had a few advantages over the rest of us in getting a head start on building wealth. As a dominant influence in Warren's life, for instance, Howard passed on to Warren the knowledge of stocks and bonds at an early age, according to the account of Warren's early childhood in the biography Buffett: The Making of an American Capitalist by Roger Lowenstein.
But the other key ingredients of what would seem to become the foundation of Warren's success appeared to stem from genetics and a sort of burning inner desire to grow money.
Lowenstein says that Buffett, "time and time again," stuns his colleagues "by computing columns of figures in his head, and by recalling encyclopedic volumes of data." Even as a child, Lowenstein says, it was "neighborhood lore" that Warren had a "photographic memory."
To what does Lowenstein suggest the credit is due for Warren's incredible abilities to compute math so easily in his head, or for his passion for making money? The biographer cites Warren's younger sister, Roberta, on the matter: "I think it was in his genes."
The point is that even if we attempt to emulate Warren Buffett's approach to building wealth, very few of us could ever invest as expertly as he does.
But don't give up hope just yet! While Buffett may be a genius, his methods of growing wealth throughout his life are easy to understand and implement.
An ambitious beginning
Buffett built up a sum of about $5,000 (close to $45,000 when adjusted for inflation) by the time he finished high school with the help of a series of entrepreneurial ventures, including a paper route and an investment in 40 acres of Nebraska farmland. Thus he established the foundation of what would become a billion-dollar portfolio.
But it wasn't until Buffett got his hands on the text Security Analysis and the book The Intelligent Investor that he really began to formulate a framework for building wealth in the stock market. Both were written by Ben Graham (Security Analysis was co-written with David Dodd), who is often considered the "father of value investing." Buffett's passion for Graham's philosophies would lead him to enroll at Columbia University for a master of science degree in economics and to earn the only A+ Graham ever granted. And shortly after he finished his graduate degree, Buffett would even work for Graham.
Buffett's wealth begins to multiply
Buffett was heavily influenced by Graham's Mr. Market parable, in which Graham likens the stock market to an obliging and moody partner who returns daily with different buy and sell offers for the other partner. The offers vary widely from day to day. Graham advises investors to only listen to Mr. Market when he offers great opportunities. Otherwise, Graham says, investors will do better to forget about the offers and pay attention to the fundamental performance of the assets in their portfolio. Buffett has been a "Mr. Market" advocate ever since he read the parable.
Graham's approach also emphasized the requirement of a margin of safety before investment. In other words, a security should trade at a discount to intrinsic value in order to provide an investor with market-beating returns. Graham, unlike Buffett, preferred to invest only in extremely cheap stocks.
Buffett began to invest his own money using Graham's approach of looking for bargain-priced stocks that carried almost no risk, and as his method slowly evolved into a hybrid that focused increasingly on durable businesses, he found his wealth beginning to compound rapidly. Between 1949, when he graduated from his undergraduate studies, and 1956, when Graham retired and dissolved his partnership, Buffett grew his personal savings from $9,800 to $140,000.
Buffett goes big-time
After his days working for Graham, Buffett saw his entrepreneurial side surfacing again. In 1956, Buffett Associates, a partnership in which Buffett managed partner money for fees, was born. By 1962, Buffett's and his wife's combined personal stakes were worth over $1 million combined.
In 1965, Buffett took controlling interest of Berkshire Hathaway, a textile business that would eventually fail. In 1969, Buffett closed his partnership and liquidated the assets to his partners.
Meanwhile, as Berkshire Hathaway's textile business shriveled up and eventually closed its doors, Buffett continued to build his investment empire under the Berkshire name. Increasingly focused on the insurance businesses, he took advantage of the float provided from the premiums by investing it wisely.
Over time, Berkshire turned into the collection of great companies we know it as today. While Buffett has acquired many companies outright under the Berkshire umbrella, the company is still growing its equities portfolio, too.
Learning from Buffett
Fortunately for those who want to learn from the world's greatest investor, whether they're investing in equities or wholly acquiring companies, Buffett's overarching formula for investing has mostly held true to the same core principles since he began his partnerships:
- Invest in enduring businesses.
- Ignore Mr. Market until he makes a valuable offer.
- Seek out ethical and competent management.
- Be fearful when others are greedy and greedy when others are fearful.
If we want to invest more like Buffett, clinging to these timeless principles should give us at least a slightly better edge in building our wealth.
Sure, Buffett's philosophy has evolved a bit. At first he focused more intensely on finding stocks trading at a significant margin of safety, whereas today, influenced strongly by his partner Charlie Munger, Buffett preaches, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." But for the most part, there is no mystery to his approach.
And given that his philosophy is actually somewhat imitable, why not learn from the Oracle himself?