Professor Prem Jain’s book on Warren Buffett compiles 20-plus years of study into a practical guide for investors, big and small.

By Chris Blose

Although you will never hear him say it, plenty of other people are willing to call Warren Buffett a genius. Authors write breathless biographies about the CEO and chairman of Berkshire Hathaway, and his investment prowess has earned him the moniker “Oracle of Omaha.” Fair enough. Buffett’s company consistently beats the market and has grown at an annual rate of around 20 percent for more than 40 years, so when it comes to investing and business sense, calling him a genius seems about right.

However, when it came time for Prem Jain, Elsa C. McDonough Professor of Accounting and Finance at Georgetown University’s McDonough School of Business, to write a new book about Buffett, he was less concerned with painting yet another biographical portrait of Buffett the genius and more concerned with answering a question:

What can we learn from him?

Jain has spent more than 20 years studying and teaching Buffett’s investment philosophies. His book, Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing (2010, John Wiley & Sons), reads as a culmination of those efforts and as a guide to investors, big or small, who want to apply Buffett principles to their own investments. Of course, learning from a genius is easier said than done.

“If it were easy to copy Picasso and Mozart, then there would be thousands of Picassos and Mozarts,” Jain says. Picasso could teach you how he paints, and Mozart could teach you how he plays and composes, but in the end, something would still be missing: the thought process and the creative spark behind their work. Buffett’s medium may be money, but the idea remains the same. By poring over Berkshire Hathaway’s books and annual reports, Buffett’s letters to shareholders, and many other types of sources, including Buffett’s own substantial writing, Jain attempts to look into Buffett’s thought process.

“I cannot claim that I have figured out exactly what goes on in his head,” Jain says. “That is impossible. But by looking at the available information, including information about how he has made investment decisions, one can come up with one’s own arguments, which is what I have done.”

Mind-reading is, as it turns out, unnecessary. “The idea is that even if you don’t do as well as Buffett has, which is unlikely, even if you have a fraction of his success, you’re going to be well above average,” Jain says.

Value and Growth
Buffett often has been cast — in popular media, books, and even on Wikipedia — as a value investor. Jain believes that is only part of the story, though.

In the book, Jain defines a value investor as “someone who invests in stocks that have such characteristics as low price-to-earnings (P/E) or market-to-book (M/B) ratios It also refers to those people who buy stocks after the market prices have fallen substantially.” On the whole, value investment represents a conservative, lowrisk approach to the market.

To combat the idea that Buffett is simply a value investor, Jain turns to the facts. Under Buffett, Berkshire Hathaway has acquired shares of stocks at or above the market’s P/E ratio: Coca-Cola, Burlington Northern Santa Fe Railway, American Express, and others. Additionally, while traditional value investors buy low and sell high, when a stock reaches or exceeds market value, independent of time, Buffett holds onto stocks for long periods of time to let them grow — 10 years on average.

Jain also turns to numbers for evidence. “An average return on investment in the market is about 9 percent over the last several decades,” he says. “Buffett’s returns are in the neighborhood of 20 percent. Value investing might produce about 11 or 12 percent, and if you can beat the market by that 2 or 3 percent, you’re doing well as an investor. But there’s a huge gap between what value investing produces and what Buffett has produced.”

So what accounts for Buffett’s success? To Jain, the answer lies in part in Buffett’s combination of low-risk value investing and carefully calculated growth investing.

In traditional growth investing, returns are very high — but so are risks. Buffett is well known as an investor who limits his risk. For example, he typically does not invest in technology because he admits to not understanding that market and not being able to predict the future of technology companies, so he avoids such disasters as the dot-com bubble bursting. However, like growth investors, he does look for companies likely to grow consistently over time. As examples, Jain offers Wal-Mart, Home Depot, Starbucks, and other companies as modern growth stocks that lack the risk of something like a tech stock. Jain recommends examining a company’s earnings over several years, because companies that have strong earnings and growth over several past years are likely to yield growth in the future, too.

A long-term view also comes with some simple mantras: Act rationally. Be patient. Don’t panic. Buffett’s cool headed attitude may account for why he did not unload massive amounts of stock during the ongoing recession as many others did; in fact, he wrote an op-ed piece in 2008 in The New York Times saying it was a good time to buy, not sell.

In short, Buffett combines the best principles from value investing and growth investing into his own philosophy that defies the dichotomy between the two.

The People Matter
As Jain illustrates through several case studies, Buffett does not assess a company’s growth potential based solely on ratios and other financial analysis. He looks at those numbers, of course, but he also looks at what he considers an even more important resource: people.

In his analysis, Buffett places a premium on the quality of a company’s management and corporate culture. His qualitative approach complements the quantitative approach of crunching a company’s financial numbers. It also speaks to his belief that consistently well-run companies will yield growth over long periods of time.

Jain offers an analogy: You walk down a city street that features multiple coffee shops. One has a line out the door, but the other is basically deserted. You may wonder about the difference.

“They’re selling such traditional products that there must be something other than the products alone,” Jain says. “In that case, I would say that the successful coffee shop probably has strong management and employees behind the counter.”

The quality of a company’s products is important, but often its management is what helps it stand out in a crowded marketplace. Buffett has a knack for finding good managers, Jain says. And when he finds them, he keeps them.

The book offers the example of three jewelers owned by Berkshire Hathaway: Borsheim’s, Helzberg Diamonds, and Ben Bridge Jeweler. In each case, Buffett got to know the owners and managers personally and became impressed enough with them to want to purchase their businesses, once he had reached the right price.

“While they are all retail jewelry stores, Borsheim’s, Helzberg Diamonds, and Ben Bridge Jeweler are run as separate businesses under the Berkshire umbrella,” Jain writes. “The principal reason is managers who made those businesses successful in the first place by keeping costs low and customers satisfied.”

The jewelry example illustrates several of Buffett’s attributes: a long-term approach to investment, faith in strong management, and the belief that if something is already working well, there’s no need to change it. These are principles even smaller investors — who are unlikely to buy entire companies — can adhere to in purchasing their own stocks.

Put simply, do your research, but make sure your research goes beyond the numbers.

Competence and Confidence
Another of Buffett’s core concepts rings true for ordinary investors, too: Stay within your circle of competence.

To illustrate, Jain offers another analogy. “When you take a sick child to the doctor’s office, the doctor will not get nervous because the doctor thinks, ‘OK, I can fix this child,’” he says. “The mother might be throwing fits because she doesn’t understand what is happening. You need to be in the same situation as the doctor, not the mother.”

Buffett was in the doctor’s position back in 1967 when he acquired two insurance companies, National Indemnity Company and National Fire and Marine Insurance Company, for $9 million. Buffett knew the insurance business well, and his understanding of that business has grown over time with big-time acquisitions such as GEICO, which became a wholly owned subsidiary of Berkshire Hathaway in 1995. In fact, insurance remains the company’s main business. Buffett and Berkshire have succeeded in insurance because of a thorough understanding of the industry.

The lesson for everyday investors is to pick your areas of focus carefully. If you already understand a particular industry well, search for and invest in the best of the best within that industry. And if you want to branch out beyond your current circle of competence, gather expert opinion and learn as much as possible about the new field you wish to enter. Buffett did not know much about jewelry when he purchased Berkshire’s first jeweler, but he turned to the expertise of the managers who had impressed him so much.

With competence comes confidence, and confident investors tend to succeed more than those who scare easily, Jain points out. Perhaps that is why he devotes two chapters of the book to the psychology of investment. You must ask yourself important questions before diving into investing, Jain says. Can you be patient when the market hits trouble, or will you follow the herd and sell, sell, sell? Are you flexible enough to change your thinking when you must? Do you think rationally or act on impulse? Can you learn from your mistakes?

In the end, Jain hopes his book will not only delve into Buffett’s mentality, but also into the reader’s and potential investor’s. He writes with a general audience in mind, but he backs up his assumptions and recommendations with a wealth of data, both quantitative and qualitative. The book has been well received critically, and Jain already has sold rights to translations including Chinese (both Cantonese and Mandarin) and Thai.

Praise and sales are nice, but Jain insists his intent in writing Buffett Beyond Value was much more intellectual than commercial.

“Warren Buffett has written so much, and he claims that most of the things he does can be copied,” Jain says. “This was my challenge. I took upon myself a challenge to understand Buffett, with academic rigor.”

Leave a Reply