Though his illustrious investing career has spanned decades and his stock purchases have covered the gamut of every business sector in diverse market conditions, Warren Buffett ’s underlying investment strategy has remained unaltered. In his 1977 Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) annual letter to shareholders, Buffett explained four fundamental investment principles from which he has never wavered, regardless of the underlying market environment.
By listing in the letter the criteria a company must meet before it will be considered for purchase, Buffett provided a synopsis of the underpinnings upon which all successful value investing is based. Buffett explained his methodology:
“We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price. ”
As an ardent disciple of Benjamin Graham, Buffett’s investment decisions are not informed by prevailing market conditions, but rather, by whether the stock in question can be had for a price that is well below its true value, or its potentially favorable future earnings capacity. As Buffett noted:
“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
The 1977 letter elaborates on another important factor in Buffett’s investment strategy: the idea of investing only in a business or sector you understand, or “Invest within your circle of competence.” In his 1996 letter to shareholders, Buffett explained why this is important for successful investing:
“What an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
One of the key distinguishing attributes of Buffett’s value investing strategy is that he doesn’t buy stock, he buys an interest in a business. As such, short-term market movements amount to nothing more than a blip on a value investor’s long-term radar screen: “We ordinarily make no attempt to buy equities for anticipated favorable stock price