In his 1996 Berkshire Hathaway Annual Letter, Warren Buffett says to be successful at investing, you don’t need to understand complex concepts like beta, efficient markets, modern portfolio theory, option pricing, or emerging markets. Instead, you should focus on two key principles: how to value a business and how to think about market prices. Your goal should be to purchase shares of easily understandable businesses at a reasonable price. Here’s an excerpt from the letter:
To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets.
You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses – How to Value a Business, and How to Think About Market Prices.
Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.
Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock.
You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.
Though it’s seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders: Our look-through earnings have grown at a good clip over the years, and our stock price has risen correspondingly. Had those gains in earnings not materialized, there would have been little increase in Berkshire’s value.
You can find a copy of the letter here:
For all the latest news and podcasts, join our free newsletter here.
Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple: