Picking Stocks Like Warren Buffett
"Who buys individual stocks? It has become an old-timey hobby for the modestly wealthy and eccentric, like model railroading." Matt Levine
When I was a teenager, Peter Lynch’s book One Up On Wall Street triggered my interest in investing. Lynch promoted the idea that individual investors can succeed in markets by being observant of their personal surroundings. They can pick up on new trends and great companies by paying attention to what people buy, by observing new stores appear in the mall, or through firsthand knowledge from their work. He made investing sound like a fun scavenger hunt. The next famous investor I came across was Warren Buffett who displayed a similar excitement about his work, famously saying that he tap danced to his office.
Robert Hagstrom and other authors have outlined Buffett’s investing methods and principles in countless books. In The Warren Buffett Portfolio, Hagstrom coined Buffett’s style of stock picking “focus investing,” as in creating a focused portfolio with a small number of high conviction positions:
“The essence of focus investing can be stated quite simply: Choose a few stocks that are likely to produce above-average returns over the long haul, concentrate the bulk of your investments in those stocks, and have the fortitude to hold steady during any short-term market gyrations.”
This was music to my teenage ears. The billionaire stock picker’s method didn’t sound complicated at all. I could do this, too!
Today I read this quote with some consternation. All you have to do is find a small number of stocks that will outperform the market? Then hold them through the inevitable volatility? In other words: remain convinced that you’re right, and actually be right, when the stocks inevitably get cut in half.
Did Hagstrom realize the gravity of that statement?
I was immediately reminded of the midwit meme.
18-year-old me, on the left-hand side: “Yes, just find some great stocks, hold, and beat the market. Don’t overthink it.”
30+-year-old me, squarely in the middle of the bell curve: “Have you lost your mind? Do you have any idea how hard it is to beat the market? The greatest investors are obsessed with the game. They’re human aliens and the most competitive people you will meet. And you want to compete with them? Have you read Bessembinder’s research on how few stocks outperform? Did you know that the market is a complex adaptive system…”
And today? Well, I have returned to appreciating the wisdom inherent in the message’s simplicity. Berkshire itself is of course an example of holding a great company for a long time and letting the magic of compounding do the work.
In 1998, Forbes wrote about the Berkshire Bunch, people who had bet big on Buffett. One of them, Stewart Horejsi reinvested capital from his family business into Berkshire. He basically modeled Buffett who allocated capital away from Berkshire’s dying textile business into more promising fields like insurance. Michael Mauboussin did something similar by betting on Amazon, and holding it through the dotcom bust, because he connected with Bezos’s team over a shared admiration of Buffett and Munger.
“The great personal fortunes in this country weren’t built on a portfolio of fifty companies. They were built by someone who identified one wonderful business.” Warren Buffett
That said, we’re obviously looking at outliers and survivorship bias. Most investors are better served with what Buffett called “insurance against ignorance”: diversification. Low cost ETFs offering the stock market return are a better option for them. But despite this established wisdom, hands-on involvement in markets seems to be making a comeback:
“Emerging customers share a couple of key characteristics. They tend to be more self-directed and self-educated. Roughly 70% of households with a net worth of $500,000 and headed by a person under age 45 had an investing style that was strongly or mostly self-directed in 2019, up from 57% in 2010, according to research firm Aite-Novarica.” In a New World: Time for Wealth Management Firms to Shift Course
I don’t think this is necessarily a bad thing. Aside from the desire for financial security or wealth, there are multiple reasons, good and bad, that lead people to pick their own investments.
Bad reasons to pick stocks
The gambling instinct. This one can seem paradoxical. Keynes wrote that it was a necessary ingredient for great investors:
“[Investing is] intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll.”
But what may be useful to the professional in measured doses can be deadly for the amateur. It’s so dangerous because it lends itself to self-deception. We all know that in Vegas the house always wins. But in financial markets you can gamble and chase dopamine hits for a long time while telling yourself that you’re really investing.
Another bad reason is the excitement of being part of the great game. George Goodman wrote about this mindset in The Money Game:
“They want to be a part of what’s going on. If you gave them a choice between making money, guaranteed, or staying in the game, every last one of them would pick staying in the game.
It doesn’t make sense, or the kind of sense you expect, but it makes a nutty kind of sense if you see it for the way it is.”
Yes, there are people who can make money trading global macro. But many traders delude themselves. They spend their days tracking the news (the new smoking) and staring at charts. They feel the rush of being part of great events unfolding. You can sometimes hear the satisfaction in people’s voices when they talk about market history, especially bubbles and financial crises. “Yep,” they proclaim, “I got that one right.” What other game allows us to place bets on world history? To become would-be Michael Burries who sniff out the next world-changing cataclysm? What other game allows us the satisfaction of feeling smarter than everyone else and getting paid for it? (Entrepreneurship is one example; as Peter Thiel: every great company is built around a secret.)
Buffett reminds us that investors “should remember that excitement and expenses are their enemies.” But what fun is that?
Good reasons to pick stocks
Hear me out: there may be rational reasons to pick stocks even if you underperform the market somewhat over time. How about:
Community and friendship; and
What do you see when you look at a picture of Berkshire Hathaway’s annual meeting?
Ok, I admit that it looks a bit cult-ish. It was an uncomfortable number of people when I went in 2009. But without a doubt, it is a tremendous community. People go to Omaha not just to listen to Warren and Charlie, maybe not even primarily. They go to see their friends and connect with strangers over a shared interest.
“Maybe the real returns were the friends we made along the way.”
I recently listened to a discussion of male loneliness on the Modern Wisdom podcast. The conversation introduced me to the idea that men are more likely to bond over shared activities as opposed to meeting just to converse. They prefer to be “side by side” rather than facing each other. There’s even a non-profit running so-called “Men’s Sheds” where men can hang out, build stuff, and get to talk as a byproduct.
Noah Smith posted a terrific thread about “how to have a friend group in your 30s” which is really about the difficulty of maintaining friend groups as you age and family and work take up most of your schedule. He touched on a similar concept, though not in a gendered way:
Well, not everyone enjoys working with their hands in sheds. Some people like puzzles and games. And investing can be exactly that. It doesn’t have to be an old-timey hobby, as Matt Levine called it. Quite the contrary, investing offers a vibrant global community with numerous tribes across a variety of social media platforms. One has to be a little careful as each community comes with its own principles and values, some of which may be harmful to your financial (or mental) health. Just complete the sentence in your head: as an investor, I am a…
It’s worth revisiting the ideas and assumptions you’ve picked up as part of your investing identity. Do they serve you well?
Nevertheless, the value of community may be under-appreciated. If we frame investing as a daily puzzle or multiplayer game to explore with friends from all over the world, it could have substantial benefits far beyond your portfolio (better relationships, better health and a longer life?).
In the land of learning machines
“I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines.” Charlie Munger
One of my favorite trait across great investors is their boundless curiosity. Their mind is running all the time, looking to discover new information, reformat old concepts, and improve their understanding of the world. They are constantly looking to update their mental software. A question worth asking yourself as an investor is: are you learning?
I still remember Liberty talking about this to Jim O’Shaughnessy.
“I'm not trying to optimize for the best returns. I am trying to optimize for happiness. … If I figure that the best place to invest right now is mining companies but I'm not interested in thinking about those companies all day long and reading about them all day long, I'm not going to go invest there.
I'm trying to use investment as a kind of lifestyle design where I'm like, "Okay. I want to make good returns. I want to make this practical." I spend enough time on it that I want to beat the market, but I also want to spend my days thinking and reading about stuff that's interesting to me. I was very lucky that the kind of stuff that interests me happens to be very good businesses like software, and infrastructure for digital stuff, and payments, and aerospace. All these kinds of businesses are interesting to me, and they also happen to be very good businesses.”
In his book Supermoney, a sequel to The Money Game, Goodman recounted his visit to Omaha which sparked a legendary TV interview with Buffett.
“After a while, around Warren, you begin to get a feel for business, as opposed to stocks moving.
‘Whether the New York Stock Exchange is open or not has nothing to do with whether The Washington Post is getting more valuable. The New York Stock Exchange is closed on weekends, and I don’t break out in hives. When I look at a company, the last thing I look at is the price. You don’t ask what your house is worth three times a day, do you? Every stock is a business. You have to ask, what is its value as a business?’
We are driving down a street in Omaha; and we pass a large furniture store. I have to use letters in the story because I can’t remember the numbers.
“See that store?” Warren says. “That’s a really good business. It has a square feet of floor space, does an annual volume of b, has an inventory of only c, and turns over its capital at d.” “Why don’t you buy it?” I said. “It’s privately held,” Warren said. “Oh,” I said. “I might buy it anyway,” Warren said. “Someday.”
Berkshire acquired the Nebraska Furniture Mart more than a decade later in 1983.
We can look at this anecdote in terms of how Buffett invests (“Investment is most intelligent when it is most businesslike.”) or we can appreciate that Buffett followed his curiosity. He spent his days on what interested him. In his case it happened to be business and securities. All of Omaha, all of the American economy, really, turned into an opportunity for him to learn. Long before there was a deal to be done, Buffett was paying attention to the Furniture Mart. It was just innately interesting to him.
I don’t walk around thinking about the economics of the businesses around me. But if you do, if investing and business are inherently interesting to you, then the time spent learning is time well spent.
As Kurt Vonnegut told a student about writing poetry: “Practice... no matter how well or badly, not to get money and fame, but to experience becoming, to find out what's inside you.” Vonnegut’s advice was to write a poem and “make it as good as you possibly can,” then “tear it up into teeny-weeny pieces, and discard them widely.”
“You will find that you have already been gloriously rewarded for your poem. You have experienced becoming.”
Yes, Buffett wanted to get rich. But he did it in a way that was interesting and rewarding to him. He enjoyed the process. It was his way of becoming the best version of himself. At the end of his life he is tearing up his fortune into teeny-weeny pieces. And yet he’s still running Berkshire. He’s still investing. He simply enjoys doing the thing.
If on the other hand an investor lacks that deep intrinsic sense of motivation and curiosity, I doubt their learning machine will ever have the same drive.
My own journey with Buffett started with youthful enthusiasm and admiration before turning into frustration (“look at what he does compared to what he says”). This was followed by rejection after attending the annual meeting (“oh my god, this is a cult!”). I’ve now closed the circle and appreciate the many layers to his life and work. I am finally happy to embrace Buffett and Munger as teachers but not idols to be worshiped.
I’ve started re-reading all the shareholder letters and listening to the annual meetings in podcast format. I’m currently sharing my favorite excerpts on Twitter but will start to collect and write them up here as well.
Buffett said he wanted to be remembered as a teacher. I believe that due to the nature of his success and wealth he typically attracts those as students who want to succeed in investing and business. People, to call a spade a spade, who want to get rich. That’s a shame. Because even though he has talked about how he picks stocks countless times, it’s really not the information you’re looking for.
His principles are deceptively simple. Yet his investment success is arguably the most difficult aspect of his life to emulate. The image of Uncle Warren buying wonderful businesses to hold them forever obscures an astonishing depth. Remove the nuance and you’re left with a platitude that may still hold value but is insufficient to grasp the many drivers of his success. It hides a lifetime obsession with learning about business and with studying human nature. It masks a relentless drive to succeed and a rarely seen inner intensity.
However, as long as we see ourselves as perpetual students, as long as we use an interest in business and investing as an outlet for learning and building community, I believe it is a worthwhile effort. Even if one does not beat the market. And hey, if you happen to come across a wonderful business or an investor or founder of Buffett’s caliber, at least you know what to do. Make a sizable bet, let the magic of compounding and patience do their work, continue to learn, and have a great time with your friends.