No matter how inexperienced you may be when it comes to the stock market, chances are you’ve heard of Warren Buffett. Warren Buffett is the chairman and CEO of Berkshire Hathaway and is one of the most famous market investors of all time. In my book, Beating Wall Street with Common Sense, I have an entire chapter devoted to the idea of value investing. Here’s some of what I write about Buffett and his trading methodology:
Known as the “Oracle of Omaha,” Buffett is one of the legends of Wall Street, having worked and invested his way from humble beginnings to become one of the world’s richest men. As part of my personal education about the market, I read a biography of Warren Buffet to understand how he made his fortune. While Buffett has used many different techniques and strategies to make money, I was interested in the most basic theme of his investment philosophy: value investing.
The idea behind value investing is to identify quality companies whose stocks are trading at a lower price than they should be for a temporary reason or for no apparent reason at all. Value investing is based on the belief that the stock market eventually values companies appropriately and that temporary fluctuations in stock price will correct themselves over time. Maybe Warren Buffett could have written a book about common sense investing because this idea of value investing made perfect sense to me at the time. Buy quality companies when their stocks are cheap, and sell them when they are expensive.
It certainly sounds simple enough, and I like simple. Buffett has consistently used the following strategy: identify companies that are undervalued, buy shares, wait, and sell them when their value has reached a more appropriate level based on the performance of the company. To say this strategy has worked for him would be an understatement, as Buffett is currently ranked the worlds fourth richest person according to Forbes. Buffett is also widely known as a generous philanthropist, having pledged to donate 99% of his fortune to worthy causes. So there’s no way the great Warren Buffet would be after your money, right? Don’t be so sure.
Over the years, Buffett’s success has inspired many imitators. These imitators often focus on identifying undervalued companies by looking for the same traits that Buffett has identified over the years. However, many of these imitators fall short of Buffett-like success, and it has nothing to do with the companies they choose or the shares that they buy. It has to do with the next step in Buffett’s process: the waiting. And waiting. And waiting.
One of my favorite Buffett quotes is, “The stock market is a device for transferring money from the impatient to the patient.” The pitfall of many modern traders is that they want profits and they want them fast! CNBC has thousands of tickers scrolling feverishly across the screen all day, and money is being made left and right! With all this cash flying around, you’d think all of us could be rich by the end of the week if we just picked the right stocks to buy, right?
Unfortunately, the market is not as efficient as we’d like to think, and often undervalued companies can remain undervalued for months and even years at a time. If you are impatient, chances are you will be selling too soon and buying too early, and Warren Buffett and other patient investors are slowly siphoning away your money. For example, one of Buffett’s most profitable investments over the years was in the Washington Post. Buffett took his initial position in the Washington Post in 1973 for $10 million. Incredibly, by 2004, Buffett had an unrealized gain of $1.7 billion on his Washington Post position! With 30 years of hindsight, this buy looks like one of the greatest purchases of all time. However, about a year after Buffett put $10 million into the Washington Post, he had endured a 20% unrealized loss on the position! In fact, it wasn’t until 1976, three years after the initial purchase, that Buffett made it comfortably above water on the position.
A more recent example of Buffett’s patience is his purchase of 700 million Bank of America warrants in August of 2011. The warrants were part of a $5 billion investment in B of A and can be redeemed by Berkshire Hathaway at any point before 2021, allowing the company to buy 700 million shares of Bank of America stock at a purchase price of $7.14 per share. When Buffett announced this deal, shares of B of A were trading at $6.88 per share. In December of 2011, shares of B of A dropped below $5.00 per share, a price that was more than 30% below the purchase price guaranteed by the warrants. I remember this drop in price well, as I was a B of A shareholder at the time. However, more than two years later, with Bank of America shares now trading above $15 per share, Buffett’s warrants look like yet another grand slam for the Oracle of Omaha.
I think many investors are aware that patience is an important part of success in the stock market. They realize that part of making money is waiting for share prices to climb. But can you wait four months? Can you wait three years? Longer? If you aren’t prepared to be patient and give the market as much time as it needs to adjust, Warren Buffett just might be taking your money. And I might be taking it too!
Want to learn more about why I chose to buy Bank of America at $6.00 per share in September of 2011? Or maybe you want to be able to look sophisticated in front of your coworkers when they ask you what you are reading on your Kindle, and you’d prefer to tell them “Oh, I’m just reading a book about stock market analysis,” rather than the usual “Oh, I’m just looking at pics of my ex-girlfriend on Facebook.” For these reasons and more, check out my book, Beating Wall Street with Common Sense. I don’t have a degree in finance; I have a degree in neuroscience. You don’t have to predict what stocks will do if you can predict what traders will do and be one step ahead of them. I made a 400% return in the stock market in five years using only basic principles of psychology and common sense. Beating Wall Street with Common Senseis now available on Amazon, and tradingcommonsense.com is always available on your local internet!
