Many investors and portfolio managers hold him in awe and see him as someone to emulate, but do they possess what we call the Warren Buffett advantage?
Being a Business Analyst First
Buffett sees himself as a business analyst, rather than as an analyst of the market, or of macro-economics, or even of securities. He looks at investments from the perspective of a businessperson, that is his main criteria for investing are the quality of management, the financial position, and the attractiveness of the purchase price. That implies that he spends considerably more time reviewing the business fundamentals of individual companies than the average investor.
In-depth Knowledge of Business Operations
Buffet has owned a large array of businesses, either as controlling or minority shareholder. As a result, he has attained a high level of familiarity with the way many business and industries operate. When he says he limits his investment selections to companies that are within his business expertise, that still encompasses a wider range of businesses that the average investor can confess to know about.
Business Experience
Years of investment and business experience have given Buffett more than just an in-depth knowledge of how businesses operate. He has acquired an insight into the vicissitudes faced by businesses. For instance, he steers clear of turn-around situations, and businesses that change course due to the failure of existing business models. He prefers simple business models which have demonstrated consistent operating histories over time. In contrast, most investors would be tempted to invest in new growth stories and company restructurings, without fully understanding the risks involved.
Independent Investor
From the start, Buffett has been able to maintain a position of independence from the wider investment community, which allowed him to pursue a somewhat unconventional investment strategy, called focused investing by some. He eschews the institutional investment decision-making process that focuses on diversification and generally accepted portfolio management techniques. Buffett believes in having a portfolio comprising a limited number of investments in franchise, rather than commodity, businesses. Unlike commodity businesses, franchises provide a product or service that is needed or desired, and that has no obvious substitute. This gives the franchise business pricing flexibility which enables it to earn above-average returns. In contrast, most investors, whether they be private investors in managed funds or institutional portfolio managers, are constrained by generally accepted industry practices and do not enjoy the freedom or wherewithal to follow unconventional investment strategies.
Close to Management
When evaluating a potential investment, Buffet assesses the quality and competence of the management. He values candor in management reporting, and rational decision-making by management in their decision to expand the business or return money to shareholders. As a director of companies, and nowadays an influential businessperson of vast wealth, he can rely on a level of personal interaction and familiarity with management that few people, including portfolio managers and analysts, enjoy to make his assessment. Most investors have to rely on the publicly available statements and financial information, combined with healthy skepticism, to draw their conclusions.
A Head for Figures
In making his investment decision, Buffet looks at the the return on equity of the business and the owner earnings, which he defines as the net income before depreciation, less capital expenditure and working capital requirements. He determines the value of a business by discounting future earnings to a present value. What is not generally known, is that Buffett is mathematically gifted, that is, he is highly proficient in the old-fashioned art of mental arithmetic, and does not need to resort to computations on calculators or spreadsheets like everyone else. This gives him the capacity to work through his investment decisions faster than the average investor.
All of this indicates that Warren Buffett, through his unique intellect, experience and position, enjoys an advantage over other investors, and which would also make it difficult to emulate his success. Of course, that is not to say that time spent learning from the master is not well-spent.
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