With a net worth of over $80 billion, Warren Buffett has already cemented himself as the greatest investor of all-time. Buffett’s conglomerate Berkshire Hathaway has grown its assets to the hundreds of billions. Currently, it has major stakes in dozens of large market capitalization companies. Although Buffett’s success may inspire the average retail investor, it is important to understand how “The Oracle of Omaha” built his wealth: value investing.
Benjamin Graham, a legendary Wall Street mogul, pioneered the idea of value investing. He mentored Warren Buffett on various concepts of value investing, including diversification, fundamental, and technical analysis. Graham wrote the book The Intelligent Investor in 1949. He detailed the ideals of value investing and the goals of a successful stock-picker. The Intelligent Investor is undoubtedly the most popular investment book in the world. Investors across Wall Street regard this book as the Bible of investing.
At its core, Buffett’s philosophy prioritizes buying a company when purchasing a stock, rather than following any technical chart or aiming for a quick buy and sell transaction. It is part of the reason Buffett has grown his holdings of The Coca-Cola Co (KO) or Kraft Heinz Co (KHC) to over $10 billion each. Buffett added shares of Apple Inc. (AAPL) because, in the words of Benjamin Graham, the tech giant “promises safety of principal and an adequate return.”
Buffett’s investment strategy mainly plays along buying companies that were once solid — or are still excellent companies — but have been deeply oversold, to the point where their price is unjustifiably low. To this end, Buffett’s purchases would likely include stocks with a low P/E ratio or little-to-no debt on their balance sheets. He looks for companies that respect shareholders and intend on delivering tangible results.
That being said, Buffett would not solely focus on the fundamental analysis of stocks. There can be a variety of red flags in companies, such as low market capitalization, high debt combined with low free cash flows, and an unsustainable management strategy. Although Buffett prioritizes the intrinsic value of stocks in its fundamentals, investors must take the entire picture into consideration
As Graham eloquently put it in The Intelligent Investor, “investing is a unique kind of casino—one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor.” Other stock traders, primarily hedge funds and HFTs (high-frequency traders) tend to trade securities with high volatility, high risk, but potentially high returns. These traders will quickly buy and sell stocks in fractions of a second, to make quick returns. They are not analyzing the value of a company. They don’t look at the management principles, the innovation over the past decade, or the room for growth. Rather, they sort through technical charts and patterns that a computer can analyze. These types of strategies oppose Buffett’s careful, pragmatic philosophy.
Whether you support Buffett’s conservative approach to investing or not, you can always learn something from value investing. Even if you choose to invest in high volatility ETFs or trade risky options, it’s important to pay attention to the main tenets of value investing, such as safety margins and risk limitation.
Value investing is an important concept to learn for the retail investor. In order to build true wealth, it is best to invest in the broader market. Legends like Benjamin Graham and Warren Buffett prove that value investing can deliver excellent returns and build that wealth.