Inside the Minds of Top Investors

Warren Buffett is widely regarded as one of the greatest investors of all time. His journey from a young stock enthusiast to the leader of a multi-billion-dollar enterprise is marked by a disciplined investment strategy and consistent long-term returns. Central to his success is his approach to value investing, which he honed during his early years working with his mentor, Benjamin Graham. But what exactly set Buffett apart, and how did he manage to achieve consistent 30% returns for over a decade?

Before Warren Buffett became the household name he is today, he worked for his father’s brokerage firm for a couple of years before joining Benjamin Graham’s firm. Graham, often referred to as the father of value investing, was Buffett’s guiding light in the world of finance. With an initial fund of $100,000, Buffett began his investment career, and in 1956, he founded his first fund, the Buffett Partnership.

This fund, which operated until 1969, delivered an average of 30% returns per year over 13 years. Achieving such a high return in a market as developed as the U.S. is no small feat. For context, even the best-performing mutual funds today struggle to hit similar benchmarks, with most hovering around 20-25%. This period marked Buffett's emergence as a unique force in the investment world, outpacing not only his peers but the market itself.

Outperforming the market for one or two years can be attributed to luck or market conditions, but consistently doing so for over half a century? That’s what makes Buffett special. While some may argue that his returns today are not as high as they once were, it’s important to remember that Buffett now manages a staggering $500 to $800 billion in assets, a sum equivalent to about 33% of India’s GDP. Even with this massive portfolio, Buffett manages to deliver around 20% returns annually—an impressive feat in today’s market.

But why has no one been able to replicate his success? The answer lies in Buffett’s consistency and discipline. Rather than chasing new trends or strategies, Buffett has remained committed to the same value investing principles that guided him from the start.

Buffett’s early investment strategy can be summed up by what he called the "cigar butt" approach. The idea behind this is simple: even a discarded cigar butt has one last puff of value. In investing terms, this meant finding companies that were undervalued, regardless of their long-term prospects. Buffett famously scavenged for these underappreciated stocks, believing that even if the company was on its last legs, it still had enough intrinsic value to offer a profitable return.

This approach was deeply influenced by his mentor, Benjamin Graham. Graham's philosophy centered on the idea that a company’s market value could often be far below its actual assets. In such cases, even a failing company could be a sound investment if purchased at the right price. Graham's strategy, developed during the Great Depression, proved timeless, and Buffett’s early career is a testament to its effectiveness.

If you truly want to understand Buffett’s investment philosophy, you need to read his annual letters to the partners of the Buffett Partnership, which are publicly available. From 1956 to 1969, Buffett wrote these letters to explain his strategies, thoughts on the market, and performance. These letters are more valuable than any traditional finance course or textbook, offering a direct window into the mind of a legendary investor.

What stands out when reading these letters is Buffett’s remarkable consistency. He didn’t change his strategy year after year, nor did he attempt to reinvent the wheel. Instead, he stuck to his core principles, refining his approach over time but never abandoning the core ideas that made him successful.

Buffett’s approach has inspired many successful investors, including Joel Greenblatt. Greenblatt is one of the few investors to have achieved a 50% compounded annual growth rate (CAGR) for 10 years. His book, The Little Book That Beats the Market, provides a simplified version of the value investing approach that Buffett popularized. Like Buffett, Greenblatt believes that the market consistently offers undervalued stocks, which, when identified correctly, can deliver substantial returns.

The key to this strategy is patience and research. Out of thousands of stocks in the market, only a handful will be hidden gems. It’s the investor’s job to identify these gems through careful analysis, much like Buffett did in his early years.

Warren Buffett’s investment philosophy was shaped by the teachings of Benjamin Graham, whose book The Intelligent Investor is considered a foundational text in the world of finance. Graham’s approach was revolutionary because it emphasized the idea that a stock’s market price often diverged from its intrinsic value. Graham argued that investors should look for companies whose market value was below their actual assets, regardless of the company’s quality or prospects.

This approach may seem simplistic, but it has stood the test of time. Graham’s theory of value investing laid the groundwork for Buffett’s success, and while many investors today overlook these principles in favor of more modern theories, Buffett has proven their enduring relevance.

One of the most famous concepts from The Intelligent Investor is the idea of "Mr. Market." In Graham’s metaphor, Mr. Market is an emotional and unpredictable character who offers to buy or sell shares at wildly fluctuating prices. The key lesson is that investors should not be swayed by Mr. Market’s mood swings but should instead rely on their own analysis of a stock’s intrinsic value. This concept is something Buffett has emphasized throughout his career and is a cornerstone of his investment strategy.

One may wonder why the market may seem to present insurmountable opportunities, which might sound crazy. For instance, in the Indian market, I’m currently tracking companies with market caps around 400 crores that have assets totaling around 2000 crores. I’ve already doubled my investment in those stocks.

The key is to analyze many companies. The theory behind this lies in understanding property value fluctuations. Do any of you own property? That’s a good question. If you do, think about how much the prices fluctuate. For example, if you bought land for one crore, when you consult a broker, they will say it’s worth one crore. If you ask again the next day, the answer will likely be the same. The maximum variation might be from one crore to 1.1 crores, demonstrating that real estate typically doesn’t experience significant mispricing.

In contrast, stock markets are influenced by people who bring emotions into play, and emotions can fluctuate. This is why stock prices are much less stable. Take Reliance, for example—a strong company in India. If I could buy one company in India, it would be Reliance, as it is a powerhouse. But even with Reliance, there’s significant fluctuation; its stock price has varied dramatically within just one year.

Now, consider whether the prices of Reliance's properties or factories change as frequently as its stock price. It’s hard to believe that the intrinsic value of such a large entity would fluctuate so wildly. This inefficiency in the market is a key insight shared by Benjamin Graham in 1935, and it remains relevant today.

There are companies with market caps of 300-400 crores that might actually be worth 3000-4000 crores. Finding these opportunities requires diligence. Warren Buffett famously found his "lottery ticket" companies, which allowed him to achieve significant returns.

While many investors achieve around 20-25% returns, which is impressive, it’s not enough for those aiming for higher returns. Buffett’s partnership structure allowed investments in both public and private markets. He categorized his investments, with some stocks performing better than others, which highlighted a flaw in his approach. Despite achieving around 27% average returns over the years, he realized that he needed more explosive growth opportunities.

Buffett’s approach shifted after he met Charlie Munger, who learned from Phil Fisher. Unlike Graham, who focused heavily on numbers, Fisher emphasized qualitative aspects of businesses. He developed a 15-point checklist to assess companies, stressing the importance of quality and thorough research.

Munger’s perspective influenced Buffett to consider not just cheap stocks but also high-quality businesses with potential for growth. This shift led to better investment decisions and higher returns.

For instance, Charlie Munger had a two billion-dollar portfolio consisting of only three stocks. This concentration strategy demonstrates the power of investing in what you understand well. Buffett himself mentioned that throughout his investing career, only about 12 stocks made a significant impact on his returns.

The principles of value investing continue to hold true, despite market trends like AI or cryptocurrency. Historical data shows that over a decade or more, value investing has consistently outperformed other strategies. The key takeaway is that you should reject 99% of investment ideas and focus on exceptional opportunities. If you want to find these companies, start with basic screening but also look for undervalued assets. Once you filter through the companies, you’ll identify the ones worth investing in.

Lee Liu, a former associate of Munger, serves as a prime example of a successful value investor. With his Phoenix Fund, Liu primarily invests in Chinese companies and has built a stellar track record. His journey from China to the U.S. exemplifies the diligence required to uncover investment opportunities, often referred to as "stalking" management and scrutinizing annual reports.

Value investing remains a viable strategy for those willing to put in the effort to research and identify undervalued companies.