When Warren Buffett hands out investment advice, you'd be a fool not to listen. Buffett, currently the fourth richest person in the world, has made himself and others very, very wealthy on the strength of his investing smarts alone. In an in-depth interview this week with CNBC, Buffett described the simple mistake most people make when they buy stocks -- they forget that what they are actually doing is investing in a business.
It's not surprising, given its effect on stock markets around the world, that the first question he got in the interview was about the coronavirus outbreak and how investors should respond. "People would be better off if they say, 'I bought a business today,' not 'a stock today,' because that gives you a different perspective," he explained. "Presumably if you buy a farm, if you buy an apartment house, if you buy a business you're going to own for 10 or 20 or 30 years, then the real question is: Has the 10-year or 20-year outlook for American business changed in the last 24 hours or 48 hours? You don't buy or sell your business based on today's headlines."
That's certainly how Berkshire Hathaway has gone about it. As Buffett reminded CNBC's Becky Quick, his company has owned shares in such companies as American Express and Coca-Cola for as much as 40 years.
Because people can make the decision to buy or sell stocks second by second, he added, they think of them as different from an investment in, say, a farm or a service station. "But it isn't," he said. "If you get your money's worth in terms of future earning power over the next 10 or 20 or 30 years, you'll have made a good investment. And you can't pick them from day to day. I haven't met anybody yet that knows how to do it."
What if the market crashes?
What about the argument that investors should hold off buying for now because the market may drop a lot further, especially if the coronavirus turns out to be as disruptive to the economy and to daily life as the Centers for Disease Control and International Monetary Fund have recently warned? "I don't think anybody knows what the market is going to do," Buffett said. "You really can't predict the market by reading the daily newspaper, that is for sure. And you certainly can't predict the market by listening to me."
On the other hand, he said, "I think you do know whether you're making an intelligent purchase at a given price." Imagine that you were going to buy shares in General Motors, he explained. It has 1.4 billion shares outstanding and let's say it was priced at $30 a share. That equates to a total value of $42 billion. "You should be able to take a yellow pad and write, 'I am buying the General Motors Company at $42 billion because ___.' and you should get it on a piece of paper."
What Buffett is talking about is valuation -- the complex science of determining what a company is truly worth. It's something he and his partner Charlie Munger are extraordinarily good at, having spent a large part of their lives studying companies and industries in detail in order to determine their value. It's the core competency that's made Berkshire Hathaway what it is.
What about the rest of us who don't have Buffett's genius and couldn't spend the time he does studying even if we did? It seems to me you have two choices. You can follow Buffett's frequent advice to consumers and invest in index funds which simply own all the stocks in a given index, such as the S&P 500. Because these funds are efficient and don't require much management, they do better in the long run than hedge funds managed by highly paid investment experts, as Buffett proved with a 10-year, $1 million bet. The second option is even simpler: Buy Berkshire Hathaway shares and benefit from Buffett's wisdom directly. But whatever you do, don't make the all-too-common mistake of selling in a panic when temporary events drive markets down.