The ideas, as published
Everything in this section is a paraphrase in this site’s own words. Nothing is quoted. The works it comes from are listed in the next section.
- A share is part of a business.
- The starting point comes from Benjamin Graham, whose student Buffett was: a share is a part-ownership of a company, and its worth depends on what that company earns over time, not on what its price did last week. Graham also described the market as a partner who offers a different price every day, which the owner is free to take or to ignore. Buffett retells that picture in the 1987 letter.
- Value is an estimate of future cash, not a fact.
- The 1992 letter and the Owner’s Manual describe the worth of a business as the cash it can pay its owners over its remaining life, counted in today’s money, an idea Buffett credits to John Burr Williams. Both documents say plainly that this is an estimate: two people with the same facts will arrive at different figures, and the figure changes as the facts do.
- A margin of safety allows for being wrong.
- Because the value is only an estimate, the price paid should be well under it, so that a mistake in the estimate need not become a loss. The phrase is Graham’s: The Intelligent Investor gives the idea a chapter of its own. The 1992 letter calls the principle, in paraphrase, the cornerstone of investment success.
- Stay inside what can be understood.
- The 1996 letter describes a circle of competence: an investor needs to judge only the businesses he or she can understand, and what matters is knowing where the edge of that circle is, not how large it is. Much of what the letters describe is declining to have an opinion.
- A good business at a fair price.
- The 1989 letter says, in paraphrase, that it is better to buy an excellent business at a fair price than a mediocre one at a low price. Buffett credits Munger with moving him to that view; the 2014 letter describes it as Munger’s blueprint for the company.
- Few decisions, and patience between them.
- The 1997 letter compares investing to a batter who need not swing at every pitch and can wait for one in the right place. Munger’s talks, collected in Poor Charlie’s Almanack, add two habits: using ideas from several disciplines instead of one, and working backwards from the ways a decision could fail, with a list of the usual errors of judgement to check against.
The sources
Named by title, author, publisher and year so that they can be found and checked. No links are given.
- Chairman’s letters to the shareholders of Berkshire Hathaway Inc.Warren E. Buffett. Published by Berkshire Hathaway Inc. each year with its annual report. The letters for 1977 onwards are published by the company. Cited here: 1985, 1987, 1988, 1989, 1992, 1994, 1996, 1997, 1999, 2004, 2007, 2008, 2014 and 2022.Used here for: The method in the authors’ own words, the purchases and their cost, and the mistakes.
- An Owner’s ManualWarren E. Buffett. Berkshire Hathaway Inc., first issued in 1996 and reprinted in the company’s annual reports.Used here for: The definition of intrinsic value, and the statement that it is an estimate.
- The Intelligent InvestorBenjamin Graham. Harper & Brothers, 1949; later revised editions.Used here for: The share as part of a business, the market as a moody partner, and the margin of safety.
- The Theory of Investment ValueJohn Burr Williams. Harvard University Press, 1938.Used here for: Value as future cash counted in today’s money.
- Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. MungerEdited by Peter D. Kaufman. First published in 2005; reissued by Stripe Press in 2023.Used here for: Munger’s talks on using several disciplines, on working backwards and on the psychology of misjudgement.
A documented example: a drinks company, 1988 to 1994
The 1988 letter reports for the first time that Berkshire had bought shares in The Coca-Cola Company during that year, and says, in paraphrase, that the intended holding period for a business of this kind was indefinite. More shares were bought in 1989 and again in 1994. The letters give the total cost as about 1.3 billion dollars.
The reasons given in the letters are the ones in the list above: a business Buffett said he understood, selling a product with a strong position in many countries, bought at a price he judged sensible for its prospects. The purchases began the year after the stock market crash of October 1987.
The holding was not sold in the decades that followed. The 2022 letter returns to it: it records that the purchases were completed in 1994 at a cost of 1.3 billion dollars, and that the yearly cash dividend received had grown from 75 million dollars in 1994 to 704 million dollars in 2022.
The example is not a clean one, and the letters say so. In the late 1990s the price of the shares rose far ahead of the business. In the 2004 letter Buffett writes, in paraphrase, that he was at fault for not selling some of the largest holdings when prices were that high. One purchase that turned out well also does not show that the method does: it is the example the authors chose to return to.
The mistakes the letters record
The letters are unusual for listing errors. The 1989 letter has a section on the mistakes of the first twenty-five years. The first on the list is buying control of Berkshire Hathaway itself: a textile manufacturer, cheap on paper, in a business with poor economics. The 1985 letter reports the closing of the textile operation.
The 2007 letter describes the purchase of Dexter Shoe in 1993 as the worst deal Buffett had made to that date. The business lost its competitive position within a few years. The letter adds that paying for it in Berkshire shares instead of cash made the mistake far more costly, because the shares given away went on to be worth many times more.
The 2008 letter records a large purchase of an oil company’s shares made when oil and gas prices were near their peak. The 1999 letter reports the worst result, compared with the wider American stock market, of Buffett’s time in charge to that point: Berkshire had stayed out of technology shares during the boom, and for a time waiting looked like an error.
Munger’s contribution here is a habit as much as an idea. A large part of Poor Charlie’s Almanack is about how capable people make bad decisions, himself included.
What can be studied with a small paper portfolio
The part of the method that can be practised without money is the analysis and the record of it. The exercise below uses a hypothetical holding and a notebook. It trades nothing.
- Choose one listed business whose product you use and believe you understand. Write, in plain words, how it makes money and what could stop it doing so.
- Before looking at the share price, write a low and a high figure for what you think the whole business is worth, and how you reached them. Expect the two to be far apart. That gap is the point.
- Decide how far under your low figure the price would need to be, and write that down as well.
- Then look at the price. Record whether it is under your line. Most of the time it will not be, and the record for that day is one line: nothing to do.
- A year later, read the company’s results against what you wrote, not the share price against what you hoped. Note where the reasoning was wrong.
- The journalBuilt for trades, but its plan and what-happened notes hold a written reason and a later review. It stays in your browser.
- Stocks, explainedWhat a share is a share of, with an invented company to divide.
A paper exercise has no cost, no tax and no fear in it. It can show whether the reasoning held. It cannot show what a real holding would have returned.
What does not scale down to a private account
- Financing terms
- Much of the money Berkshire invests is insurance float: premiums held between the day they are paid and the day claims are settled. The letters discuss it regularly. A private person has nothing like it. Borrowing against an account is the opposite kind of financing: it costs interest and can be called in during a fall.
- Access to deals
- The letters describe buying whole companies by negotiation, and securities bought directly from an issuer on terms that were never offered to the public. Neither is available through a dealing account.
- Information and staff
- The method rests on decades of full-time reading of company reports, and on being able to speak to the people who run the businesses. A private investor has the published reports and little else.
- Tax treatment
- A company that holds shares for decades is taxed differently from a private person, and holding without selling puts off the tax on a gain. How a private holder is taxed depends on the country and the kind of account.
- Time horizon
- Berkshire has no clients who can ask for their money back, so it is never forced to sell in a fall. A person who may need the money for a house, a job loss or retirement does not have a horizon of several decades for all of it.
- Liquidity, in reverse
- Size works against a very large investor: the letters say repeatedly that large sums can only go into large companies. A small account can buy almost anything, but being able to buy a small company is not the same as being able to judge one.
- A leveraged CFD is a different thing
- A contract for difference on a share gives no ownership, no vote and no place on the share register. It is usually leveraged, it usually carries a financing charge for every night it is open, and it can be closed out by a margin call. Waiting, which is the heart of this method, is exactly what such a contract charges for.
Questions people ask
- What is a margin of safety in investing?
- It is the gap between what an investor estimates a business is worth and the lower price actually paid. The idea, from Benjamin Graham’s The Intelligent Investor (1949), is that the estimate may be wrong, so the price should be far enough under it that an error need not become a loss. It lowers the chance of overpaying. It does not remove the risk of loss.
- Can I copy Warren Buffett’s portfolio from public filings?
- Not in any real sense. Public holdings reports are published weeks after the date they describe, cover only some kinds of holding, and give neither the price paid nor the reason. A copier buys later, at a different price, without knowing whether the position has since changed. A private account also lacks the financing, tax position and time horizon that the original holder has.
- Did Buffett and Munger make mistakes?
- Yes, and the shareholder letters record them. The 1989 letter lists the mistakes of the first twenty-five years, beginning with the purchase of Berkshire Hathaway’s own textile business. The 2007 letter describes the 1993 purchase of Dexter Shoe as the worst deal Buffett had made to that date. The 1999 letter reports a year far behind the wider market.
The words on this page
A summary for study of ideas that are on the public record, in this site’s own words. It is not endorsed by, or connected with, anyone named. Nobody at GIO4X has access to their portfolios. Studying a method does not reproduce its results, and a leveraged CFD is not ownership of an investment and does not behave like one. Educational information, not investment advice or a recommendation to trade.