Over the last 49 years, Warren Buffett managed to achieve a 24.7% annual compounding rate of return, which means he doubled his money every 2.9 years for half a century! He turned an initial investment of $100,000 into a staggering $42 billion. How was he able to consistently beat the market (only 10% of professional fund managers are able to beat the S&P 500 Index every year) and all the smartest money managers on Wall Street?
Here are two lessons an investor can learn from the master himself
Lesson One: Invest from a Business Perspective
Warren Buffett invests from a business perspective. Most people treat stocks like lottery tickets. Buying and selling based on predictions of whether the price will go up or down in the short term. Based on world events stock prices go up and down randomly and erratically, hence there is no way anyone can consistently beat the market by attempting to predict its movements. Many of these punters know every little about the business operations behind the stocks they own.
Warren Buffett knew that buying a stock meant becoming a part-owner of an ongoing business. The only way to consistently make money was to identify very good businesses run by a strong management team. Good businesses would over time generate higher and higher profits. Increasing profits will increase the value of a company and hence its share price. By honing his expertise in sniffing out companies that had the potential to generate huge amounts of earnings growth over time, he was confident that the stocks he held onto would increase significantly in price over time.
Lesson Two: The Market is Irrational, Take Advantage of It
While most financial experts teach that the market is rational and efficient (stock prices reflect the true value of a company), Buffett knew that stock market prices were determined by demand & supply, which in turn are irrationally driven by fear and greed. As a result, a stock’s price did not always reflect the true value of a company. In times of mass investor optimism & greed, buyers rush in and push a stock’s price way above its value. In times of fear and panic (i.e. news of a recession) investors sell their shares, causing a stock’s price to fall way below its value.
The Market tends to overvalue a company’s stock when there is good news and under-value a company’s stock when there is bad news.
Warren Buffett’s beliefs, philosophies and investing strategies are totally contrary to the average money manager or individual investor. Today, his company Berkshire Hathaway is the most expensive company in the world, with a share price of $100,000 per share.