Warren Buffett may have been born with business in his blood. He purchased his first stock when he was 11 years old and worked in his family’s grocery store in Omaha. His father, Howard Buffett, owned a small brokerage, and Warren would spend his days watching what investors were doing and listening to what they said. As a teenager, he took odd jobs, from washing cars to delivering newspapers, using his savings to purchase several pinball machines that he placed in local businesses.
His entrepreneurial successes as a youth did not immediately translate into a desire to attend college. His father pressed him to continue his education, with Buffett reluctantly agreeing to attend the University of Pennsylvania. He then transferred to the University of Nebraska, where he graduated with a degree in business in three years.
After being rejected by the Harvard Business School, he enrolled in graduate studies at Columbia Business School. While there, he studied under Benjamin Graham – who became a lifelong friend – and David Dodd, both well-known securities analysts. It was through Graham's class in securities analysis that Buffett learned the fundamentals of value investing. He once stated in an interview that Graham's book, The Intelligent Investor, had changed his life and set him on the path of professional analysis to the investment markets. Along with Security Analysis, co-written by Graham and Dodd it provided him the proper intellectual framework and a road map for investing.
Benjamin Graham and The Intelligent Investor
Graham is often called the "Dean of Wall Street" and the father of value investing. One of the most important early proponents of financial security analysis, Graham was so influential that he helped draft the Securities Act of 1933. He championed the idea that the investor should look at the market as though it were an actual entity and potential business partner – Graham called this entity "Mr. Market" – that sometimes asks for too much or too little money to be bought out.
It would be difficult to summarize all of Graham's theories in full. At its core, value investing is about identifying stocks that have been undervalued by the majority of stock market participants. He believed that stock prices were frequently wrong due to irrational and excessive price fluctuations (both upside and downside). Intelligent investors, said Graham, need to be firm in their principles and not follow the crowd.
Graham wrote The Intelligent Investor in 1949 as a guide for the common investor. The book championed the idea of buying low-risk securities in a highly diversified, mathematical way. Graham favored fundamental analysis, capitalizing on the difference between a stock's purchase price and its intrinsic value.
Entering the Investment Field
The Buffett that modern investors admire almost wasn’t. When he graduated from Columbia he intended to work on Wall Street, but Graham convinced him to make another career choice. Heading back to Omaha, Buffett worked as a stockbroker and created several investing partnerships. The size of the partnerships grew substantially, and by the time he was 31 he was a millionaire.
It was at this point – in 1961 – that Buffett’s sights turned to directly investing in businesses. He made a $1 million investment in a windmill manufacturing company, and the next year in a bottling company. Buffett used the value-investing techniques he learned in school, as well as his knack for understanding the general business environment, to find bargains on the stock market. Looking for new opportunities, he discovered a textile manufacturing firm called Berkshire Hathaway (BRK.A), and began buying shares in it. He later took control of the company in 1965. He made some other good investments, like American Express (AXP), a company that doubled in price within two years of his initial purchase of its stock.
Comparing Buffet to Graham
Buffett has referred to himself as "85% Graham." Like his mentor, he has focused on company fundamentals and a "stay the course" approach – an approach that enabled both men to build huge personal nest eggs. Seeking a seeks a strong return on investment (ROI), Buffet typically looks for stocks that are valued accurately and offer robust returns for investors.
However, Buffett invests using a more qualitative and concentrated approach than Graham did. Graham preferred to find undervalued, average companies and diversify his holdings among them; Buffett favors quality businesses that already have reasonable valuations (though their stock should still be worth something more) and the ability for large growth.
Other differences lie in how to set intrinsic value, when to take a chance and how deeply to dive into a company that has potential. Graham relied on quantitative methods to a far greater extent than Buffett, who spends his time actually visiting companies, talking with management and understanding the corporate's particular business model. As a result, Graham was more able to and more comfortable investing in lots of smaller companies than Buffett. Consider a baseball analogy: Graham was concerned about swinging at good pitches and getting on base; Buffett prefers to wait for pitches that allow him to score a home run. Many have credited Buffett with having a natural gift for timing that cannot be replicated, whereas Graham's method is friendlier to the average investor.
Buffett Fun Facts
Buffett only began making large-scale charitable donations at age 76.
Buffett has made some interesting observations about income taxes. Specifically, he's questioned why his effective capital gains tax rate of around 20% is a lower income tax rate than that of his secretary – or for that matter, than that paid by most middle-class hourly or salaried workers. As one of the two or three richest men in the world, having long ago established a mass of wealth that virtually no amount of future taxation can seriously dent, Mr. Buffett offers his opinion from a state of relative financial security that is pretty much without parallel. Even if, for example, every future dollar Warren Buffett earns is taxed at the rate of 99%, it is doubtful that it would affect his standard of living.
Buffett has described The Intelligent Investor as as the best book on investing that he has ever read, with Security Analysis a close second. Other favorite reading matter includes:
- Common Stocks and Uncommon Profits by Philip A. Fisher, which advises potential investors to not only examine a company's financial statements but to evaluate its management. Fisher focuses on investing in innovative companies, and Buffet has long held him in high regard.
- The Outsiders by William Thorndike, Jr. profiles eight CEOs and their blueprints for success. Among the profiled is Thomas Murphy, friend to Warren Buffett and CEO of Berkshire Halloway. Buffett praises Murphy in a 2012 shareholder's letter, calling him "overall the best business manager I've ever met."
- Stress Test by former Secretary of the Treasury, Timothy F. Geithner, chronicles the financial crisis of 2008-9 from a gritty, first-person perspective. Buffett has called it a must-read for managers, a textbook for how to stay level under unimaginable pressure.
- Business Adventures: Twelve Classic Tales from the World of Wall Street by John Brooks is a collection of articles published in The New Yorker in the 1960s. Each tackles famous failures in the business world, from Ford's doomed Edsel to dysfunctional price-fixing at GE, depicting them as cautionary tales. Buffett lent his only copy of it to Bill Gates, who reportedly has yet to return it.
The Bottom Line
Warren Buffett’s investments haven't always been successful, but they were well-thought-out and followed value principles. By keeping an eye out for new opportunities and sticking to a consistent strategy, Buffett and the textile company he acquired long ago are considered by many to be one of the most successful investing stories of all time. But you don't have to be a genius "to invest successfully over a lifetime," the man himself claims. "What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."