Individual investors are back. Throughout 2021, they directly invested billions of dollars in U.S. stocks and real estate. But these assets are now priced at troublingly high levels, and fears of a correction are feeding volatility. Rising U.S. inflation, taxes, and government debt present systemic challenges. Political and social discord prevail. And there’s COVID.
Facing such turmoil, individual investors are eager for guidance. There are few better sources than Berkshire Hathaway’s
Warren Buffett, renowned for a matchless investment record across six volatile decades as well as for his savvy, accessible advice for investors. On point is this gem from 1994:
“Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%. But, surprise — none of these blockbuster events made the slightest dent in [fundamental] investment principles.”
As unprecedented as these times may seem, from angst to innovation, another Buffett gem reminds us that we’ve been here before. In 2018, Buffett wrote again of how the fundamentals of investing are timeless:
“Since 1942… the country contended at various times with a long period of viral inflation, a 21% prime rate, several controversial and costly wars, the resignation of a president, a pervasive collapse in home values, a paralyzing financial panic and a host of other problems.”
Buffett has always believed that the fundamentals of investing remain intact even in the face of financial fads or innovations, from the tech bubble of the late 1990s to today’s meme stocks or social investing funds.
The fundamentals of investing are collated in homespun and humorous essays Buffett has been writing for the shareholders of his company, Berkshire Hathaway, for six decades. Since 1996, with Buffett’s support, I have published a collection of the best of these, representing a comprehensive, non-repetitive and compact mini-course useful to any individual investor.
In this year’s essay, Buffett warned about the perils of investing by individuals, particularly now in a period brimming with “promoters” telling “stories” that create “illusions” for the gullible. Springing to mind are SPACs, ETFs, ESG funds, and other fashionable offerings. Buffett cautions against “speculators” peddling “enticing ideas” and “calls for action” that “never stop.”
Buffett advises avoiding such lures. In contrast, he uses two examples from his own investing experience to highlight the appeal for investing of common sense, simplicity and business focus. The examples are his investments in an Omaha farm (in 1986) and a New York City apartment building (in 1993) in which he earned outsized returns by adhering to just a few fundamentals.
First, Buffett has long said the three most important words in investing are “margin of safety.” He refers to the phrase coined by his mentor, Benjamin Graham, who stressed that investment opportunities arise when priced below value. Buffett purchased the farm from a failed banker, and the building from a government receiver. They were eager sellers offering low prices given market conditions. Hunting for such safety is especially important in current highly-priced markets.
Second, Buffett says “keep it simple” and “don’t swing for the fences.” He isn’t an expert in farming or real estate. But he understood enough to estimate revenues and expenses on these assets over a decade-long holding period. Buffett estimated a 10% return, which he judged reasonable for the moderate risk. In fact, both of these investments saw earnings triple estimates and their value quintuple. If you keep it simple, meaning invest in things you understand, you only need basic competence to comfortably make economic estimates.
Finally, Buffett advises to “focus on the playing field, not the scoreboard.” By this he means to study the asset and related business prospects rather than any market price. In stocks, for example, focus on the value of the expected cash flows over the next 10 years, not on today’s closing price; for an office building, focus on the value of the expected rent rolls, not on the sales price of the building down the block.
Individual investors know that investing is not easy and that choppy waters can make things uncomfortable. Following the fundamentals helps, as does the perspective that history provides.
Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of “The Essays of Warren Buffett: Lessons for Corporate America.” Cunningham owns shares of Berkshire Hathaway. For updates on Cunningham’s research about quality shareholders, sign up here.