Warren Buffett is arguably the most renowned investor and billionaire in the world – even if Bill Gates has about 20 times more followers on Twitter than the Oracle of Omaha.
What makes Warren Buffett's rise into the elite category of "billionaire" so intriguing is that he did it entirely through investments. Quite a few of today's billionaires, by comparison, had quite the head start via inheritance or family fortune. Buffett had less than $10,000 to his name in the early 1950s, and now, a little more than six decades later, his net worth sits at more than $70 billion, with his conglomerate Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) sporting a $352 billion market valuation -- good enough for the fifth-largest market cap among all companies listed on major U.S. exchanges.
If this astronomical rise in Buffett's wealth weren't enough proof of his self-made success, his company has also outperformed the S&P 500 in terms of book value growth about 80% of the time over the last 50 years. It's for this reason why more than 40,000 investors flock to Omaha each and every year to Berkshire's shareholder meeting to hear what Buffett has to say.
Buffett's secrets to success
Although Buffett tends to be direct with his investments, his secrets to success may not be readily apparent. While somewhat arguable, (because let's be real, there are a lot of things Buffett does right that the normal investor struggles with), I believe these are his three biggest secrets to success.
1. He focuses on income generation and reinvestment
First, Warren Buffett has a knack for seeking out stocks that are capable of running on autopilot. As Buffett has previously been quoted, "I try to buy stock in businesses that are so wonderful that an idiot can run them, because sooner or later, one will."
This method of thinking allows Warren Buffett to focus his and his company's investable efforts on solid dividend-paying businesses.
Source: Pictures of Money via Flickr.
"Why dividends?" you wonder? To begin with, dividends imply the long-term strength of a company's business model. A company wouldn't pay out regular dividends to its shareholders if it didn't have an optimistic long-term outlook. Dividends also help to buoy Berkshire Hathaway's portfolio when the U.S. economy hits its inevitable bumps in the road about once or twice every decade. Most importantly, though, Buffett can funnel the dividend payments received from his holdings and reinvest them either back into more shares of the same company or a brand new investment.
To bring this concept into context, Coca-Cola (KO 0.35%) paid Berkshire Hathaway $88 million in dividends in 1995. This year, Coca-Cola is expected to pay out $528 million to Berkshire based on the 400 million shares it owns. With Coca-Cola's 53-year streak of increasing its payout, Buffett's income generating strategy and focus on buying companies that can run on autopilot is truly "paying dividends."
2. He utilizes dollar-cost averaging to his advantage
Another of Buffett's secrets to success is that he relishes in the idea of being able to dollar-cost average into the companies Berkshire is purchasing.
The general public doesn't exactly hope the companies they buy simply maintain their value or head lower. We'd like to buy a stock and see it ascend to the heavens immediately. But not Buffett. Instead, Buffett believes in edging into the companies he finds most attractive over the course of multiple quarters and even years. Because he believes in an exceptionally long holding period (Buffett's not into "flipping" his holdings unless something very material changes with the underlying business model), Buffett actually welcomes weakness in the companies he owns because it gives him the opportunity to accumulate even more shares.
Source: Flickr user Celestine Chua.
It's important to recognize that Buffett won't always be right. Even the best investors in the world are going to be wrong from time to time, and his fairly recent investment and sale of Tesco stock at a loss is a good example of this.
But, dollar-cost averaging can turn into lucrative profits over time. Recently, the Oracle of Omaha has been pushing heavily into cloud-computing and data center specialist IBM (IBM +1.65%). Previously a hardware king, IBM is in the midst of a multi-year transition that's taking longer to figure out than Wall Street (or even IBMs management) had predicted. That's bad news for short-term IBM investors, but it's great news for Buffett and his faithful followers as it gives them a chance to accumulate shares in a company with a good potential to turn itself around.
IBM still generated better than $17 billion in operating cash flow over the trailing 12-month period and is valued at only 10 times forward earnings. If its turnaround does indeed take hold within a few years, Buffett, and Berkshire Hathaway's 79.57 million shares of IBM, could be sitting on a veritable gold mine.
3. He innovates rather than follows
Lastly, Buffett may take ideas from books he reads and lectures he attends, but the decision to buy a stock and the investment thesis derived in that decision are entirely his own.
Buffett's innovation can be traced all the way back to his beginnings and the creation of Berkshire Hathaway. Many companies have tried to imitate Buffett's Berkshire Hathaway, but none have the business diversity or capital to outperform the S&P 500 in four out of every five years.
Buffett also tends to think contrary to the crowd and invests in decades-old, or century-old innovations. Some of Buffett's purchases over the last couple of years include Heinz, a company that began producing ketchup in 1907; BNSF, a railroad company operating in an environment where drones and electric vehicles are the next big thing; and Duracell, a commercial battery maker since the 1950s. Only Buffett would be brave enough to build his conglomerate around these brands, but it's tough to argue against the overwhelmingly successful results.
The rest is up to you
So how can you apply these secrets of success to your own investment portfolio? Consider adding a few solid dividend-paying companies to your investment or retirement portfolio as they can provide a good foundation to protect against market volatility all while adding the potential for reinvestment.
Also, consider investing your money in regular intervals to avoid trying to time the market. Buffett is working with billions of dollars, which makes averaging down on his schedule very easy. For the average American the prospect of averaging down on an investment might seem painful. This is where buying stocks at regular intervals could be a smart plan.
Lastly, understand that while Buffett and other market gurus are great idea generators, you are the ultimate innovator of your investment portfolio. You have to be willing to decide what companies or ideas are going to continue to revolutionize and better society. Make the commitment to become informed on a subject or subjects that interest you and use that knowledge to become a great investor.
