The “cocktail party” stock tip is something we’ve all heard about, and maybe even experienced ourselves, delicious pig-in-blanket in hand. Or perhaps your Great-Uncle Irv is always whispering in your ear about that “sure thing” he heard about from his broker while fitting in eighteen holes at the club. And there’s certainly never a shortage of expertly coiffed, smartly dressed, and sometimes smart-sounding guys and gals on television telling you what they think you should be investing in. While it may be tempting to listen to any or all of them and jump into a stock you know little to nothing about (when has Uncle Irv ever steered you wrong?), resist!
Buffett believes, and you should, too, that you need to put in ample research time before buying shares of a company. It’s not enough just to know a ticker symbol; you need to understand what the company does, how it makes its money, and just who is running the show. This level of reconnaissance is a productive means for figuring out if you’re looking at an enterprise with a durable competitive advantage and strong moat, or just another here-today-gone-tomorrow pretender. You can’t know all that without doing the work, folks. (As a side note, it’s amusing to think about how much research someone will do before buying a new computer or car or refrigerator, but when it comes to investing their hard-earned money in public companies—in buying a part of a business, remember—many people are content to listen to others and do as little as possible themselves.)
Luckily, we’ve got things a whole lot easier than Buffett did back when he first started reading about and researching companies. Thanks to the Internet, the quick, largely free access we have today to financial information is seemingly limitless. Buffett had to go in person to the Securities and Exchange Commission to see company filings. “That was the only way to get them,” he’s said.1 It was a similar story for some Moody’s and Standard & Poor’s reports. He’d have to show up and request the documents he wanted on specific companies from their library, and then sit, going through them bit by bit, taking notes for himself. He didn’t even have the benefit of a copy machine!2
When he wasn’t hanging out at Moody’s, Standard & Poor’s, or the Securities and Exchange Commission in person, Buffett was hauling around those giant Moody’s and Standard & Poor’s manuals. He started this habit when he was in business school at Columbia, learning from his mentor Ben Graham to dig for potential investments.
These aren’t 100-page paperbacks we’re talking about, either. Think 10,000 pages for the hardcover Moody’s Manuals, covering just about every public company under the sun and moon. Buffett has said he went through all the Moody’s Manuals twice—all 10,000 pages—when he was working as a stockbroker at his father’s Omaha firm, looking at each and every business.3
Buffett also wasn’t above visiting companies in person to learn more about them and talk to management face-to-face. He first did this with GEICO (now owned in full by Berkshire Hathaway) when he was a graduate student. Having heard that Graham’s investment firm liked the company, Buffett decided to investigate further. He showed up at GEICO’s corporate offices on a Saturday and before long, found himself quizzing a vice president about the company’s financials and prospects. Shortly thereafter, Buffett invested a substantial chunk of his money in GEICO’s stock.
Buffett’s insatiable desire to learn everything and read everything he can get his hands on is legendary. He’s an absolute sponge, soaking up far more information than seems humanly possible. He devours annual reports, business magazines, and books aplenty. He reportedly reads at least five newspapers a day, and has been reading the Wall Street Journal daily since he was in college.4 In fact, once he was living and working back in Omaha he arranged to have the Journal delivered early to his office each morning, so he’d have a jump on everyone else when it came to the latest financial news.5
Buffett’s days in his modest Omaha office are usually spent reading, from the time he gets in until the time he heads home. He reads about seven hundred annual reports a year, taking forty-five minutes to read each one cover to cover. Talk about using your time wisely! He has optimized this time-consuming process perfectly. Given that he’s mostly just sitting around reading all day, he’s talked before about how boring his time at the office would look to an outsider. (Although I have to say, as someone who absolutely loves to read, this sounds pretty heavenly to me.)
His nights typically aren’t that different. His three adult children have talked about their father’s reading habits when they were growing up; he’d go up to his study upstairs after supper and read until he went to sleep—they knew not to disturb him unless absolutely necessary.6 Buffett is simply driven to absorb as much knowledge and information as he can.
One benefit from this is that he can often make complex financial decisions faster than most of us—math whizzes or no—would feel comfortable doing. Because he’s spent so much time learning in detail about the financials of nearly every company he might feasibly be interested in owning, he can quickly assess potential deals. About his ongoing prep work, Buffett has reportedly said, “Noah did not start building the Ark when it was raining.”7 Buffett reads to stay ready for new business propositions in addition to keeping up with the financials of Berkshire’s current holdings.
Buffett’s mind is razor sharp and his power to recall information is astonishing. Andrew Kilpatrick, author of Of Permanent Value: The Story of Warren Buffett, says that “he is in fact a genius and the rest of us mortals can’t relate to that. If you tell people he can read and absorb a book in one sitting, people don’t believe it because they can’t do it.”8
But while it certainly helps, you don’t have to possess his remarkable intellect and near-perfect memory to succeed as an investor. (Thank goodness! Most of us would be sadly out of luck were these traits nonnegotiable requirements. And remember, too, what Buffett himself said about temperament trumping IQ in investing.)
You do need to crave knowledge as he does, though. It’s not necessary to request early delivery of the Wall Street Journal, or read five newspapers a day, or spend your evenings at home holed up with a stack of annual reports. You’ve likely got other things to attend to, right? But to become a better investor, you’ve got to become a lover of businesses and a better scholar.
You’ve got to learn the basics of accounting, so you’ll know your way around a balance sheet, for instance, and won’t be flummoxed when someone’s talking about accounts receivable or goodwill. You’ve got to read about different business models, to understand how they make money.
How is discount giant Wal-Mart’s approach different from jewelry store Tiffany’s, for example? They’re both retailers, but they practice very different approaches to business. The answer? Wal-Mart sells a whole lot of things with very little markup, a high volume/low margin strategy, while Tiffany chooses to sell fewer, higher-quality items but makes more money off each one. (Oh, and naturally, there’s the fact that Wal-Mart doesn’t use those cute little robin’s egg blue boxes and doesn’t have a legendary movie with its name in the title starring the one and only Audrey Hepburn. But I digress.)
You’ve got to become comfortable with the peculiar language of business, and to get there, you’ve got to embrace reading about it. Having a healthy curiosity about the world around you helps. Buffett’s eternally curious, and this is a huge asset for him. You can never be sure where your next great investment idea or possibility is going to come from. Being open to learning about anything and everything provides you with the mental makeup to embrace new ideas.
THE BENEFITS OF BEING CURIOUS AND WELL-READ
“It matters because the world is complex and the world is adaptive. I don’t know why this is, I don’t have a theological or epistemological foundation for this, but it has come to my attention time and time again that there are patterns in the world that repeat across seemingly unrelated systems. So there are things about the markets that appear to me to be very similar to the way that biological systems work. Or there are analogies, there are recurring patterns that are similar, and we sure know a lot more about biological systems than we do about the markets, and so if I can study biological systems and they can give me any little insight into how this works, that’s helpful. And it’s really indirect, so I don’t want to make it sound like, ‘Well I study nerve systems and I figure out that this works that way.’ It’s really very indirect and very amorphous.
“There’s also the element of historical patterns, not just systems, but events, such as the way that wars happen, the way that cultures evolve, the way that demographics have affected countries, the way that natural events have affected countries—again, amorphous, indirect, but they provide greater connections in your brain, your brain becomes more robust, and the pattern recognition machine becomes better. You make connections that other people might not make. That’s at a very broad level.
“At a more practical level, a curious person is more likely to uncover the piece of information that will be the evidence you need to have higher confidence than the next guy that is not curious enough to be resourceful. You know, someone who’s basically like, ‘I get this. I understand how this works. I don’t need to think about it all that much.’ Whereas someone like me, or the people who work for me, are always asking, ‘How else can I think of that? What am I missing? What else is happening? What else could I do? How else could I turn this on its head? What else could I research to figure out if this is right or not?’
Now, this isn’t to say that Buffett’s going to spend a lot of time—nor should you—reading about and following in detail the companies that lie outside his circle of competence. As we talked about earlier, he very clearly defines which industries and types of companies fall into his circle and then he sticks to it. Thanks to his curiosity, it’s not a stretch to imagine him keeping up with some companies that fall outside his circle in a peripheral kind of way, but not with the same depth and intensity he devotes to the companies he fully understands.
As we found earlier, because of the fast-moving and ever-changing nature of technology, for example, Buffett doesn’t feel comfortable trying to predict their future cash flows. It’s unlikely, then, that he’s spending a significant amount of time reading about tech companies, outside of some of the biggies that we know fascinate him like Microsoft and Google. His research time and brainpower are better focused elsewhere. This is a lesson for us, as well. Unless you are certain that diving deep into new areas is going to bring them within your circle of competence, you are probably better served by continuing to learn as much as you can and deepening your knowledge about the industries and companies you are already comfortable with.
Another key asset for Buffett is his ability to avoid what’s known as “confirmation bias,” the very human tendency to seek out only information that confirms a conclusion we’ve arrived at, versus challenging it.10 We’re biased toward news that pleases us; question us, and not so much. It’s the grown-up equivalent of sticking your fingers in your ears and yelling nonsense when you don’t want to hear what someone’s telling you.
However, avoiding negative information can be deadly for investors. Letting confirmation bias rule your investment decisions can compound mistakes, because it can make you unwilling to admit you made one in the first place. As we’ll see later in our chapter on mistakes, Buffett is uncannily good at admitting he’s made them. It may hurt his ego, it may upset him, but when new information presents itself that disproves something he believed, he analyzes it and accepts it. Writing about a purchase he made of oil company ConocoPhillips when oil prices were sky-high and then subsequently plummeted, he says, “so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.”11
When you don’t take the time to question your thinking, to consider what could go wrong, to noodle on what you could be missing in your analysis, you automatically increase your risk. And we know that Buffett believes you should do everything you possibly can to reduce your risk. Making sure you’ve considered alternate points of view helps you do this. You won’t be perfect at it; no one is. But trying to think about all points of view—not just the ones that indicate you’re right—is tremendously helpful.
Writing in his 2008 letter to Berkshire Hathaway share-holders about the human inclination to want approval for one’s investment ideas, Buffett said, “Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”12
So, in order to get the most out of the time you spend researching (a real necessity to becoming a great investor):
• Read, read, read. (You can check the appendix in the back for a list of books, if you want a place to start.)
• Don’t forget about your circle of competence.
• Avoid confirmation bias—actively seek out information that contradicts your conclusions, not only information that reinforces them.