Warren Buffett: What You Should Ask When Buying A Stock

Key Concepts

• Learning from Failure: The value of experiencing and analyzing unsuccessful business ventures.
• Continuous Learning & Adaptability: The importance of constantly updating one’s understanding and being willing to discard outdated beliefs.
• Scuttlebutt Method: Gathering information through conversations and questioning industry participants.
• Opportunistic Investing: Capitalizing on market panics and dislocations.
• Behavioral Economics & Rationality: Observing and avoiding irrational financial behaviors, like those seen in Puerto Rico and Europe.
• Humor as a Reflection of Accurate Perception: Viewing the world realistically often reveals its inherent absurdity.

The Value of Experiencing Business Failure

Warren Buffett and Charlie Munger emphasize the profound learning opportunity presented by running, or closely observing, a poorly performing business. Buffett states, “I really think if you want to be a good evaluator of businesses… you really ought to figure out a way without too much personal damage to run a lousy business for a while.” He believes that the lessons gleaned from struggling with a “terrible business” for a couple of years are far more valuable than those learned from a consistently successful one, where the business’s inherent strength obscures potential pitfalls. This is because a good business can mask deficiencies in an investor’s understanding, while a bad business relentlessly exposes them. Munger echoes this sentiment, stating, “There’s nothing like personal painful experience if you want to learn.” They acknowledge the experience isn’t desirable (“I wouldn’t advise too much of it”), but undeniably impactful. The core takeaway is that failure provides a stark education in the realities of business, demonstrating the limitations of intelligence (“IQ does not solve the problem”) and the difficulty of rectifying fundamental flaws.

Continuous Learning and Adapting to a Changing World

Both Buffett and Munger highlight the necessity of continuous learning and the willingness to abandon previously held beliefs. Munger describes himself as a “learning machine” with a broader absorption rate than Buffett’s more specialized focus. Buffett acknowledges the accelerating pace of change in the world, stating, “It’s a world that gets more fascinating all the time… and a lot of fun can occur when you learn you were wrong on something.” This willingness to admit error and adapt is crucial. Buffett quotes an unnamed source, stating, “The problem is not in getting the new ideas but shedding the old ones,” underscoring the difficulty of overcoming cognitive biases and outdated perspectives. This adaptability is demonstrated by their evolving investment strategies, noting they would not have made certain acquisitions (“Iscar,” “Precision Cast Parts”) a decade earlier, signifying a growth in their understanding and capabilities.

The Scuttlebutt Method and Qualitative Analysis

Buffett credits Phil Fischer’s 1958 book, Common Stocks and Uncommon Profits, with introducing the “scuttlebutt method” – a technique of gathering information through informal conversations with industry participants. He describes a specific tactic used when researching industries like coal: asking company executives to hypothetically invest all their family’s money in a competitor, and conversely, to short a competitor. This approach, he believes, can reveal valuable insights into the competitive landscape and underlying economics. While acknowledging its limitations (“It doesn’t solve everything”), Buffett emphasizes its potential for uncovering information not readily available through traditional analysis. He illustrates this with examples from American Express (the salad oil scam) and Apple, demonstrating the long-term application of this qualitative research method.

Behavioral Economics and Avoiding Irrationality

Munger provides examples of systemic failures stemming from irrational behavior, specifically referencing the bankruptcy of Puerto Rico and the government bond portfolios in Europe. He points out that Puerto Rico’s fate was predictable due to “idiotic” behavior, and that sensible investors (“everybody is being sensible at Berkshire”) avoided its bonds. Similarly, he notes the absence of Greek bonds in European portfolios, highlighting a widespread recognition of their inherent risk. This illustrates a broader principle: avoiding investments based on flawed logic or unsustainable practices. Buffett and Munger emphasize the importance of rational decision-making and avoiding the pitfalls of “printing money and lying.”

Opportunistic Investing and the Benefits of a “Fairsized Repertoire”

Buffett and Munger describe their investment approach as opportunistic, actively seeking to capitalize on market panics and dislocations. Munger likens this to “playing with two hands instead of one in a game that requires two hands,” suggesting that a broad skillset and preparedness allow them to exploit opportunities others miss. This requires a “fairsized repertoire” of knowledge and experience, built through continuous learning and a willingness to adapt.

The Role of Humor and Accurate Perception

When asked about his sense of humor, Buffett attributes it to his perception of the world. He states, “If you see the world accurately, it’s bound to be humorous because it’s ridiculous.” He credits Charlie Munger with an even better sense of humor, suggesting that a clear-eyed view of reality often reveals its inherent absurdity. This perspective underscores the importance of intellectual honesty and a willingness to acknowledge the complexities and contradictions of the world.

Technical Terms:

• Scuttlebutt Method: A qualitative research technique involving gathering information through informal conversations and questioning industry participants.
• Behavioral Economics: The study of the psychological factors that influence economic decision-making.
• Short Selling: A trading strategy where an investor borrows shares and sells them, hoping to buy them back at a lower price to profit from the decline.
• Bond Portfolio: A collection of debt securities (bonds) held by an investor.
• Bankruptcy: A legal process for individuals or businesses that cannot repay their debts.