The first took place in 1986, when Buffett purchased a 400-acre farm from the FDIC for $280,000, even though he had absolutely no idea how to operate a farm. However, Buffett's son loved farming, and put together some projections of the farm's production and expenses. From this, Buffett calculated the farm would produce a normalized return of about 10%, which he estimated would improve over time.
Then, in 1993, a commercial real estate bubble burst, and Buffett acquired a New York retail property adjacent to the NYU campus. Obviously, the location was great, and Buffett again calculated a 10% return on investment. Plus, he also realized that the property had been poorly managed, and the buildings largest tenant was paying 93% less than market rent, and their lease would expire in nine years -- which meant amazing future potential to grow revenue. Buffett still hasn't seen the property.
The six lessons to learn
Why did Buffett share these stories with Berkshire's shareholders? It's certainly not because he's trying to convince them to buy farms and retail buildings. Rather, he knows that Berkshire shareholders are investors, and these two stories illustrate some of the most important lessons investors can ever learn.
Here are the six fundamentals of investing Buffett shared, and how they apply to individual investors choosing stocks to buy.
1. "You don't need to be an expert in order to achieve satisfactory investment returns. But if you're not, you must recognize your limitations ..."
Buffett didn't understand the farming business, but it is a simple enough business that he understood how a profit is made and what could lead to growth over time. Similarly, when you look at some of Berkshire's subsidiaries and stock holdings, the same logic applies. For example, I doubt Buffett was an expert in the candy-making business before he acquired See's Candies. However, it was a simple enough business and the numbers made sense.
In contrast, Buffett doesn't understand most technology-related businesses, so he's not going to buy one. You can apply this to your own portfolio -- stick to what you understand best. You don't need to know everything about the business, but you should have a firm grasp on the business model.
2. "Focus on the future productivity of the asset you are considering. If you don't feel comfortable making a rough estimate of the asset's future earnings, just forget it and move on."
For your purposes, don't worry about the stock price -- buy businesses and assets because you feel strongly about their future profitability and growth. This is why Buffett likes businesses that pass the "50-year rule." If you look at Berkshire's asset portfolio, you'll see a bunch of timeless businesses. In 50 years, people will still need food, insurance for their possessions, homes, and safe places to keep their money. Will they still need iPads? Maybe, but maybe not.
3. "If you instead focus on the prospective price change of a contemplated purchase, you are speculating."
There is nothing wrong with speculating from time to time, as long as you don't confuse it with an investment. For example, during the recent commodities crash, I bought shares of copper miner Freeport McMoran at fire-sale prices. The stock could double, or it could have easily fell to nearly zero if things didn't work out -- but the point is that I knew this going in, and only invested a small amount. Buffett went on to give one of my favorite quotes on speculation: "Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game."
4. "With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations."
If you focus on the daily prices of your stocks, not only is this unproductive, but it tends to cause investors to make reckless decisions. When the market is panicking, investors who watch their portfolio constantly tend to panic as well and sell their stocks at rock-bottom prices. And, when investors see trendy stocks going up and up, they see everyone else is making money and get greedy, buying shares while they're expensive. The basic point of investing is to buy low and sell high, but price-watching encourages the opposite.
As Buffett said, "If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays."
5. "Forming macro opinions or listening to the macro or market predictions of others is a waste of time."
As I write this, there is a headline on one of the major financial news websites that implies the past few days' rally in the markets is going to continue for months and that the correction is all but over. Just a few headlines down, on the same page, there is another article that says the weakness in the market will last for years. Obviously, both of these can't be accurate.
Nobody has a crystal ball that can predict all of the market-changing variables that can occur. It's entirely possible that we'll get lots of great news that will catapult the Dow Jones back to 18,000 by year's end. Or, we're just a few bad news items away from another leg down or even a full-blown crash. It's anyone's guess. Don't worry about predictions and invest for the long run.
6. "My two purchases were made in 1986 and 1993. What the economy, interest rates, or the stock market might do in the years immediately following -- 1987 and 1994 -- was of no importance to me in making those investments. I can't remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU."
This sums it up nicely. If you buy great companies at fair prices, you shouldn't care what the market or individual stock price does over the next year, or even the next several years. Over time, you'll make money. Consider that if you had purchased shares of Berkshire Hathaway on January 1, 2008, your shares would have lost 50% of their value before the market finally bottomed in early 2009. Today, you would be up 43%. The same logic can apply to any stock you purchase.