Warren Buffett and a Reflective Journey

Thanks to Groww’s email, I came across this story of Warren Buffett that startles my mind. It talks of habits; indeed, I’m not here to discuss his personal habits but his investing habits.

We’re habituated to things; as a baby, we saw elders, followed their footsteps, and did what they did. A baby/toddler questions simple things around the house that may change your perception. Like why do we cry? Is life just a dream - questioning our limits of perception of reality.

Well, let’s not get too philosophical on our investing blog. The point is we should introspect things and change our habits. Here’s the story.

Warren Buffett follows some rules just like you and me while investing.

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A stock’s price is centred around the business a company does.

This is where valuation comes in to picture. This is a vast field you can spend weeks learning, but in short, it’s a measure of a stock’s price being fair (or not fair).

The price-to-earnings ratio (PE ratio) is one of the most popular metrics to measure the valuation though it isn’t the only one.

So, if too many people buy a stock, its price rises. The higher its price rises, the higher its valuation is - unless its earnings also rise.

There’s a specific style of investing - value investing - that pays great attention to a stock’s valuation.

The idea is that you should buy undervalued stocks and sell stocks that become overvalued.

Of course, it isn’t that easy.

There is no ‘right’ valuation. There is no clear definition of overvalued and undervalued.

It’s subjective.

Warren Buffett makes comments on valuation if he has cash and feels that the markets are overvalued, he will not invest. The rule is simple, don’t invest in overvalued stocks.

Let’s jump to his other rule, which says stay within your circle of competence.

In short, don’t invest in an industry you aren’t well aware of. Simple rules. But Warren was taken aback in the late 1990s and 2000s, a new kind of stock came to rise: The internet tech stocks.

In my MBA classes, the teacher threw a question that why didn’t the dot-com boom last long. The reason was that businesses were taken aback by the swarm of orders they couldn’t fulfil and paid dearly with their hard-earned reputation; hence most of them collapsed. The other reason that we discussed is summarised in this article. Dotcom Bubble - Overview, Characteristics, Causes.

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Warren back in those days said the stocks were overvalued, and it turned out he was right; many internet companies crashed, shut down, and threw people jobless. But the portfolio of Warren wasn’t taken aback by the massive hits as the of the other investors.

Having proven right, Warren stayed away from internet stocks after the dot com bubble.

Warren Buffett deeply admired Jeff Bezos for creating and running Amazon. He was wildly optimistic about the company.

But, the Amazon stock price was always in a range that Warren deemed overvalued. So he never invested.

In 2008, Warren’s cautious approach was validated again when the Great Recession hit.

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Even after the dot com bubble of 2000, the internet tech stocks reached a level where Warren would simply not look at them.

It still seemed like somewhat of a bubble to him.

In the 2010s, seeing the internet tech stocks rise meteorically, Warren realised that tech stocks work differently.

The returns in Tech were too high to ignore, and finally, in 2016, Warren bought Apple’s share.

Fast forward to today - 40% of Warren’s total investments are in Apple. Made over $100B from Apple in the last five years - owns 5% of Apple. Chunks of Amazon and the recent IPO Snowflake, Warren’s a prominent investor in that.

You see, he broke his own rule, and the returns are massive.

Times change, people evolve, conditions convert, and rules die.

Rules save time and effort.

But now and then, it makes sense to ask: why does this rule exist?

Image Credits due to their respective owners