Billionaire investor Warren Buffett has been active again in the markets lately, including building a large stake in oil company Occidental. As we move towards September, I think some practical lessons from Buffett’s investing career could help me when it comes to my own investing. Here are two I plan to apply when assessing shares for my portfolio in the coming month.
Focus on the business model not just the industry
Will electric vehicles become increasingly important in years to come? I think the answer is probably yes. Could the industry become huge? Again, the answer is yes.
Does that mean that I ought to invest in electric vehicle shares like Tesla and NIO? Not necessarily. If we go back to his 2009 letter to shareholders in Berkshire Hathaway, we find Buffett making the following comment: “Just because Charlie (Munger) and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy”.
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In other words, an industry may have tremendous promise – but in its early days, it can be hard to judge who the victors will be. As hosts of competitors “battle for supremacy”, there could be price wars and company subsidies that make it hard to make money even in a booming part of the economy.
I think that helps explains why Warren Buffett mostly sticks to industries that already have a proven profitability model. He also likes to invest in companies that have shown they know how to make money consistently. Buffett does not always stick to this approach in practice, as shown by his investment in Chinese electric vehicle business BYD. But in general, I think hunting for bargains in proven industries rather than trying to spot winners among dozens of firms in rapidly evolving ones makes sense for me as an investment strategy.
Warren Buffett on margins of safety
Warren Buffett also emphasises a lesson he learned from investment guru Ben Graham on the importance of always investing with a ‘margin of safety’. As an investor, there may be many opportunities that come along and look quite attractive. I see some right now and any market turbulence in September may make them look even more attractive.
However, Buffett’s approach, based on having a margin of safety, means that instead of impatiently nibbling at the first decent opportunity that comes along, an investor should wait patiently for what looks like a great one. As the Sage of Omaha puts it, using a baseball analogy, this is like waiting for a “fat pitch”.
Such opportunities are rarer by definition. But even if they end up performing less well than hoped, the margin of safety could help give me a positive return. Instead of dabbling in shares I think merely look quite good, it could be more lucrative for me to follow Warren Buffett and wait for the ones I think look truly sensational.
