In the inaugural issue of CFA Magazine there's a question and answer session with a half dozen or so notable investors called "Living Legends."
I thought that Warren Buffett gave the best answers to the questions posed and have excerpted them below.
Which one or two experiences, good or bad, as an investor actually taught you the most useful or the best lessons,
and what were those very best lessons?
Buffett: The best lessons I learned were from Ben Graham, and they came about when I read The Intelligent Investor
when I was 19. I'd been interested in stocks since I was 7 or 8 years old. I'd computed my own averages, and had read every investment
book in the library. I was having a lot of fun but I wasn't going any place. I got three ideas out of Ben's book that have been the
cornerstone of everything I've done, which are to look at stocks as part of a business rather than simply things that go up and down.
And then I took to heart his Mr. Market saga, which I think is vital to having the right attitude toward market fluctuations. Then third,
the margin of safety. Now if you're looking for lessons from my own experience, I bought my first stock when I was 11 -- three shares of
Cities Service Preferred at $38. My older sister bought three shares also. It went down promptly to $27. This is when the Dow was at
92 in June of 1942. As we walked to school every day, she reminded me of the most recent price. I was tired of hearing about it, so,
when it got back to $40, I sold my shares and she sold hers. It went on to be called at $212 a share or something like that not long thereafter.
So, I decided from then on not to talk to anybody about what I did and just think by myself.
What one piece of advice would you consider most important if you were advising a 25- or 30-year old investment
professional on how to be successful over his or her career?
Buffett: I'd say be realistic in defining your circle of competence. Try to figure out what you're capable of knowing, stay
within that, and forget about everything else. It means deciding which businesses you know enough to value and which ones you don't know
enough to value. You can't expect other people to do your thinking for you either. You have to really understand the businesses that
you're buying through the medium of stocks. And unless you're willing to put a lot into that, you shouldn't expect to get much out of it.
And never forget that anything times zero is zero. No matter how many winners you've got, if you either leverage too much or do anything
that gives you the chance of having a zero in there, it'll all turn to pumpkins and mice.
Looking back over the last 30 years, what are the most important changes in the fundamental nature of our
profession? And then looking out over the next 30 years, what do you think will be remembered from today that's really significant?
Buffett: The interesting thing to me is how little investment professionals have learned. John Bogle will have better figures
on this than I, but if you look back 30 or 40 years to the turnover of portfolios within professionally managed funds, I believe the turnover
ratio was a small fraction of the turnover ratio now experienced. There's not been a greater focus on actually looking to long-term prospects
of a business and what I would think of as trying to prosper from the actions of the business rather than the actions of the stock over the short term.
And looking out 30 years, I think those comments will probably still apply. The ultimate irony of the investment business is that there's no
question that the obstetrician will deliver babies better than the husband or the wife. Or if you take dentists as a whole, they will
remove teeth or fill teeth better than if the patients try to do it themselves. But in the investment world, somebody who believes in American
business -- and who will seek out the lowest way to participate in business and do it consistently -- will achieve results that exceed those
of investment professionals as a group. It's the only industry I can think of where the professional's efforts subtract value from what the
layman can do himself.
What would you be recommending to the president with regard to corporate governance?
Buffett: The only real way to get improvement in corporate governance is to have big investors demand it. A relatively small
number of large institutional investors who decided they would withhold their votes when they saw excessive compensation or poor
performance, I think, would have a real impact on corporate governance, but I don't think legislation will. The tax law can govern the horizon
of investors, and it may be about the only thing that can govern the horizon that investors utilize. But in the end, to get better
corporate governance, you have to have owners who are true owners, and they have to behave like owners.
Given the option to say whatever you would like to say that, 30 years from now, bright, young people would be
sitting down and reading, saying, "Gee, I'm glad I was able to read this particular thought," what would that thought be?
Buffett: I would say to only buy a stock that you'd be comfortable owning if they closed the stock exchange for three years tomorrow.
Always leave a margin of safety, stick with what you understand, and quantify.
© 2003, CFA Magazine
To understand the irrationality of stock prices, imagine you and Mr. Market are partners in a private business.
Each day without fail, Mr. Market quotes a price at which he is willing to buy your interest or sell you his.
The business that you own is economically stable, however, Mr. Market has incurable emotional problems.
At times he feels euphoric and names a very high buy-sell price because he fears that you will snap up his interest
and rob him of imminent gains. On other occasions he will name a very low price, terrified that you will unload your
interest on him and saddle him with unimaginable losses.
Mr. Market has an endearing characteristic: he doesn't mind being snubbed. If you ignore him today, he will show
up with a new offer tomorrow. Transactions are strictly at your option, the more manic-depressive his behavior, the
better for you. But like Cinderella at the ball, you must heed one warning or everything will turn to pumpkins and
mice: Mr. Market is there to serve you, not guide you. It is his pocketbook not his wisdom that you will find useful.
If he shows up some day in a particularly foolish mood, you are free to either ignore him or take advantage of him, but
it will be disastrous if you fall completely under his spell.
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