Buy the Business not the Stock

Warren Buffett, the Oracle of Omaha, has amassed a substantial fortune from astute investments through his company Berkshire Hathaway. Berkshire Hathaway has outperformed the stock market for decades and investors all over the world study Buffett’s investment approach and ideas for insight. Fortunately for all of us, Buffett generously shares his views on investing through many forums including his letters to Berkshire Hathaway shareholders, the Berkshire Hathaway annual meeting, and many public appearances. Some of this insight is outlined in his 12 principles for buying a business.

When you buy stock you are buying a piece of a business; that seems obvious. But it is not often the way people think about investing. To others day trading and investing seem like the same thing but they are not. Having the right perspective is the difference between winning and losing.

Warren Buffett and his Partner Charlie Munger explain that owning stock is (should be thought of as) business ownership. In their Berkshire Hathaway “Owner’s Manual” for shareholders the first of their thirteen owner related business principles is explained in part:

“Although our form is corporate…Charlie Munger and I think of our shareholders as owner-partners, and of ourselves as managing partners. We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.”

“Charlie and I hope that you do not think of yourself as merely owning a piece of paper whose price wiggles around daily and that is a candidate for sale when some economic or political event makes you nervous. We hope you instead visualize yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family. For our part, we do not view Berkshire shareholders as faceless members of an ever-shifting crowd, but rather as co-venturers who have entrusted their funds to us for what may well turn out to be the remainder of their lives.”

Tweedy Browne Company, LLC, an investment firm established in 1920 with a long history and deep roots in value investing explains further in a semi-annual report:

“…those in the business of predicting market movements are seemingly looking at different facts since there is not much agreement among them…we believe the task of trying to get the “market direction” right over a limited time period is not the best way to evaluate the merits of any particular investment. Put simply, we operate with a different investment horizon and a different perspective. As investors, we own businesses and we like the productive capital- building nature of their assets. Our job is to try and determine what that business will look like in three to five years and buy it at a discount from our estimate of business value. If we can get these variables about right, our expectation is we will make out very well over time.”

I have a confession to make. I shamelessly follow the advice of proven and successful investors most of the time. If I don’t I think long and hard about why not because they are often the source of great investing ideas. The best are telling us:

  1. To be successful in investing your perspective needs to be that of a business owner.
  2. As investors our job is to try and determine what the business will look like in three to five years.
  3. Investors have to think and behave like a business owner and that takes work.
  4. Day traders watch stock “price wiggles” and try to get “market direction” right.
  5. Day trading doesn’t take as much work, few if any can do it well, it’s not investing and it is not nearly as effective.

“Opportunity is missed by most people because it is dressed in overalls and looks like work.” Thomas Edison (1847-1931); Inventor, Businessman

The 12 principles for buying a business are his principles for buying a stock. They are summarized below and discussed often in Berkshire Hathaway’s annual letters to shareholders and many publications including “The Warren Buffett Way” by Robert G. Hagstrom.

Warren Buffett’s 12 Principles for Buying a Business

Business Principles:

  1. Simple and understandable business.
  2. Consistent operating history.
  3. Favorable long term prospect (franchise).

Management Principles:

4. Rational management.
5. Candid with shareholders.
6. Resist institutional imperative.

Financial Principles:

7. Focus on return on equity not earnings per share.
8. Calculate owner’s earnings for estimate of true value.
9. Look for companies with high profit margins.
10. One dollar premise: each dollar retained must yield at least one dollar in increased market value.

Market Principles:

11. Know/estimate the intrinsic value of the business.
12. Buy the business at a discount to intrinsic value.