Chandnee Sinha

July 12, 2007 14:14 IST

Warren Buffett, probably the greatest investor of his generation, rarely communicates his investment ideas in writing to the general public.

And why should he? If someone has that extra edge when it comes to making money from the stock markets, he would rather use it for himself rather than go around sharing it. But once a year, he makes an exception to the rule and does give out his way of thinking through the annual letter he writes to the shareholders of Berkshire Hathaway.

Other than this he has given many speeches over the years, which have given the general public some idea of the way he thinks. Here are a few of these gems which he has shared with his shareholders over the years through his letters and speeches.

1. Buy the business and not the stock

The speech titled, 'The Superinvestors of Graham and Doddsville,' delivered to the students of Columbia Business School in 1984, remains the most famous speech that Buffett ever made.

This speech was delivered at a seminar held to celebrate the 50 years of the publication of Benjamin Graham and David Dodd's book Security Analysis. Benjamin Graham was Warren Buffett's Guru at Columbia School and all the years that Graham taught there Buffett was his only student to have got an A+ grade.

And Buffett, as we all know, has surely lived up to that grade. This speech elucidated his firm belief in the principle of value investing. Value investors, he said, "search for discrepancies between the value of a business and the price of small pieces of that business in the market." Hence, the only thing they are bothered about is "how much is the business worth?"

As Buffet said in the speech, "He's not looking at quarterly earnings projections, he's not looking at next year's earnings, he's not thinking about what day of the week it is, he doesn't care what investment research from any place says, he's not interested in price momentum, volume or anything. He's simply asking: What is the business worth?"

And hence, as Buffett points out in the speech about value investors. "While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock."

As we all know, the question 'how much is a business worth?' is not easy to answer and depends on how closely the investor follows the business of the company he is investing in and the understanding he has of that particular line of business.

Buffett himself follows this and does not invest in businesses he does not understand. Information technology is one sector he has consciously stayed away from even at the height of the technology boom.

2. Buy when the stock prices are low

One of the peculiar things about stock markets is the fact that investors like to buy when the markets are doing well and the stock prices are on their way up. This is not the best way to invest given the fact that in everyday life we like to buy more of something only when the prices are low.

Buffett explains this point in his letter to the shareholders for the year 1997. "A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?"

"These questions," he goes on, "of course, answer themselves. But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the 'hamburgers' they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."

3. For investors as a whole, returns decrease as motion increases

Getting into stock because everyone around you is and hoping to make money from it money successfully is not everyone's cup of tea. As more and more investors get into the same stock, and price rises, the chances of making money from the stock go down.

In his 2005 letter Buffett wrote, "Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: he lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: 'For investors as a whole, returns decrease as motion increases.'"

4. There is a thin line separating investment and speculation

Buffett explains this beautifully in his letter to the shareholders in the year 2000. "The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money."

"After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities -- that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future -- will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands."