The Truth Behind How Warren Buffett Sees Ahead of the Crowd

Warren’s gift is being able to think ahead of the crowd. It requires more than taking his aphorisms to heart to accomplish that. Although, Warren is full of aphorisms well worth taking to heart. — Bill Gates

Disclosure: I’m a Berkshire Hathaway shareholder.

In 2016, I was lucky enough to ask Warren and Charlie another question at the Berkshire Hathaway Annual meeting.

You can watch it here:

Despite making my question complicated and tripping over myself to get the question out, Warren managed to deliver timeless insight for those looking to create an extraordinary business, institution, or impact in the world.

Q: Warren, what elusive yet obvious to you truth that has allowed you to think ahead of the crowd and build a clear mental framework to produce a historically significant institution and powerhouse brand? — Bruce Wang

Principle 1: Get the best teachers you can

I owe a great deal to Ben Graham in terms of learning about investing and owe a great deal to Charlie (Munger) in terms of learning a lot about business. — Warren Buffett

In Warren’s case, he first chose to study under the world’s best finance teacher, a man who defined value investing through his seminal works, “The Intelligent Investor” and “Securities Analysis”. And second, he was wise and alert enough to eventually apply the lessons Charlie Munger shared with him about “getting great businesses at fair prices instead of fair businesses at great prices.”

He famously pursued Graham for employment, and even offered to work for free. Warren always quips Graham said he was overpriced! Despite numerous rejections from Graham, his persistence paid off and he was awarded a position at Graham’s firm at the tender age of 24.

Warren, already well ahead of the investment pack in his 20s and 30s, created much success through his “cigar butt” strategy. Purchasing ugly, worn-down companies sold at stock prices well below their Net Tangible Asset value, Warren essentially secured a “free puff” where when the stock price corrected itself and he, in turn, sold it to realize a profit.

Later on, Charlie pressed for a more scaleable business model: purchasing companies with a form of durable advantage such as branding, pricing, or distribution power; ideally, a confluence of multiple competitive advantages operating at once.

Not an easy feat to convert someone as independently minded as Warren to switch away from strategies that have been so successful for him.

Behold the power of associating well.

Principle 2: Develop a lifetime obsession

I’ve spent a lifetime looking at businesses and why some work and some don’t work. As Yogi Berra said, “you can see a lot just by observing”. And that’s pretty much what Charlie and I have been doing for a long time. — Warren Buffett

Warren started his investment story as a paper boy developing an early and essential understanding of how to take care of customers and budget an enterprise. He read every investment book in his library by the age of 11. This prodigy grew into a man who has written a thoughtful and useful Berkshire annual letter on investing each and every year for the past 50 years.

He reads about 500 pages a day in the forms of Annual Reports, five newspapers, 10-Ks, biographies and books. Combine this fanatical work ethic and thirst for knowledge with his peculiar mental faculties, it becomes clear how Warren developed a genius level of understanding and intuition about what makes some businesses great and why others fail or fall short.

Clearly, Warren’s early obsession with investing and his continual pursuit of investment mastery coupled with compound interested has yielded a tremendous return for his shareholders, his family, and all of human civilization through his substantial charitable donations.

When asked at a philanthropic dinner, to what do you most attribute to your success? Warren Buffett and Bill Gates both replied, “focus.”

Principle 3: Play to your unique and most valuable strengths

I mentioned pattern recognition earlier…and it’s important to recognize what you can’t do. So we may have tried the department store business and a few things but we’ve generally tried to only swing at things in the strike zone and our particular strike zone. And it really hasn’t been much more complicated than that. — Warren Buffett
Ted Williams’ Strike Zone

Warren often cites, “The Science of Hitting” by baseball Hall of Fame player Ted Williams who divided up the “Strike Zone” into the possible combinations a pitcher may legally throw the ball.

What’s remarkable about this diagram is that Williams indicates which sections of the strike zone he had a higher probability of hitting. Thus, to increase his odds of hitting success, he waited for pitches to be thrown into his high percentage hit zones otherwise known as the “sweet spot.”

For Warren, investing is a lot like hitting except there’s no three strike rule. He can look at thousands of investable opportunities and commit only to a business he understands for a sensible price he’s willing to pay. Once you see that you have a high probability of making it a big success. Swing for the fences. Warren would commit a significant and meaningful sum to the right investable opportunity to make a significant and meaningful amount of profit.

Concentrating your efforts on areas you excel not only increase your probability of success, but also maximize the impact of that success.

Warren has seen thousands of businesses over the years, yet Berkshire only represents a collection of 80-some businesses. But those 80 businesses have created over $300 billion in market capitalization. Warren designed Berkshire around maximizing his unique talents of capital allocation.

You don’t need the IQ in the investment business that you need in certain activities in life but you do have to have emotional control. — Warren Buffett

Just as important, don’t react emotionally to stock price fluctuations and pull out of the market irrationally. These often represent the best time to purchase a great asset at an even cheaper price.

Warren also cautions us about swinging outside of your sweet spot or operating outside your “circle of competence”. Many bright and ambitious entrepreneurs and business people get caught in this trap of chasing “shiny objects” by going into businesses they don’t fully understand and losing focus.

How do you know if you’re in your sweet spot or doing something stupid? Well, if you have to ask the question of “whether a particular endeavor is in your sweet spot”, you are already exposing your ignorance’s to the subject.

We see very smart people do very stupid things. It’s fascinating how humans do that. — Warren Buffett

Principle 4: Avoid self-destructive behavior

Take the people who get very rich and leverage themselves up in someway that they lose everything. They are risking something that’s important to them for something that isn’t important to them. Well, you say you could figure that one out in first grade. But people do it time after time. And you see that constantly self-destructive behavior one sort or another. And it doesn’t take a genius to do it but I think we’ve avoided the self-destructive behavior. — Warren Buffett

The most common culprits to business decay are what Warren calls the “ABC’s of Business” — Arrogance, Bureaucracy, and Complacency.

It takes a vigilant leader to fight off these pervasive human tendencies within their organization as well as within themselves. These destructive forces often begin to emerge after companies become successful.

It’s all too easy to become arrogant or complacent once you’ve had great success and believe you now have the Midas touch. One may begin to dive into business activities that are outside their arena of competency. Others may rest on their laurels and lose their competitive edge. More bureaucratic companies unwisely add layers and layers of proverbial red-tape, complicating the decision-making process, festering a lack personal accountability and initiative throughout their organization.

In Warren’s example, highly leveraged enterprises may understand how to substantial amplify capital returns through leverage. But, some get greedy, arrogant, or both. They still have to service their debt, even when unforeseen recessions hit and revenues contract which can lead to a downward spiral where employees are laid off, cash flow is negative, new capital is hard to raise, and the company runs out of money.

Principle 5: Behave well

And I think there’s another factor that accounts for the fact that Berkshires done so well as it has — we’re really trying to behave well…None envied this man’s success so fairly won and wisely used. That’s a very simple idea. But it’s exactly what Berkshire’s trying to do. — Charlie Munger

Year after year, decade after decade, Warren communicated, a consistent set of principles and behaviors. He cultivated the tone at the top through this words and actions.

From initial force of personality to cultural inertia, Warren and the Berkshire Managers shaped a culture of integrity, intelligence, and initiative. They built a long-term reputation for win/win partnerships.

But it started with Warren.

Warren had to be, and continues to be, that vigilant leader. He continually works at removing his own ignorance’s, publicly admits his mistakes, recognizes his managers contributions, acknowledges the importance of luck, invests in noble enterprises, and lives a humble yet determined life. A reputation and fortune fairly won and wisely used.

There are a lot of people who made a lot of money and everyone hates them and they don’t admire the way they made the money. And I’m not particularly admirable at making money running gambling casinos and we don’t own any. And we’ve turned down businesses including a big tobacco business. So I don’t think Berkshire would work as well if we were just terribly shrewd…We want to have people think of us as won fairly and used wisely. It works! — Charlie Munger

Principle 6: Acknowledge the reality of luck

Think of how lucky you were to have your Uncle Fred. Warren had an uncle that was one of the finest men I ever knew…Some people have terrible relatives! — Charlie Munger

If you’re lucky enough to have incredible relatives who reinforce admirable qualities throughout your youth, you’re well ahead of the game and very fortunate. I too was so very lucky to be born to wonderful parents and a loving and exceptional family.

Perhaps you weren’t born to a good family or in the right town at the right time. There’re so many who are suffering and struggling with the current socio-economic forces encapsulated in their region. Many are going through unimaginable times migrating from their homes to escape war, famine, and suffering.

We were very very lucky to be born when we were and where we were. — Warren Buffett

These factors may legitimately affect your ability to perform. You may have limited access to good teachers. It may be hard to meet better friends or work at a specific field of occupation. It’s very difficult to write software if you have no access to computers, let alone electricity.

Fortunately, luck happens to everyone eventually. The trick is, will you be ready and prepared to take advantage of the opportunity when luck hands it to you? Will you have the persistence and grit to make it a success and see it through adversity? Are you committed to a lifelong obsession that goes beyond your current circumstances?

Principle 7: Be patient and opportunistic

Well there’s a few simple tricks that work well. And particularly you’ve got a temperament that has a combination of patience and opportunism in it. And I think that’s largely inherited or I suppose it could be learned to some extent. — Charlie Munger

Developing a sense of optimism about the future is a wonderful and useful character trait. It gives you hope that better times and opportunities will arise in the future. And they almost invariably do.

But it will take more than hope; it will take determination. Hope just keeps you mentally and spiritually in the game.

Warren and Charlie both cultivated deep knowledge, connections, and capital through prudence and patience. They knew there would be better opportunities to allocate their capital in the future. Once they received a “pitch in their sweet spot” in the form of a mis-priced stock opportunity, they we’re prepared to swing big and opportunistically, putting their hard won resources to work.

When Warren was asked, “how do you find good deals?”

“Start with A.” — Warren Buffett

Warren was referring to the Moody’s manual. Starting at A, he would sift stock by stock and page by page and year after year to find the best investment opportunities. Another example of the legendary work ethic that produced legendary results.

World-class results happen as a proactive response to lucky breaks and opportunities. The quality of your response will be dependent on the degree of preparation, alertness, intelligence, focus, execution, intuition, and persistence applied to make the opportunity a success.

Stay focused and never give up.

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