To invest like Warren Buffett, first learn how he thinks about different categories of investments. At the 2011 annual Berkshire Shareholders’ Meeting, Warren Buffett suggested that all investments can be divided into three categories.
The first category of investments is anything denominated in currency – bonds, deposits, money market fund, cash in pocket. If you reach into your pocket and pull out your wallet, you will see the words, ‘In god we trust’. It should actually say ‘In government we trust’, for any currency related investment is a bet on how government now and the future will behave. For example, if you decided to make currency related investments in Zimbabwee, it would have been a bad decision because of the terrible inflation that the government of Zimbabwee was not able to deal with.
Almost all currencies have declined in value over time – this is built in to any economic system, for it is easier to work with currency that declines in value than currency that increases in value. Thus, currency-related investments as a class do not make much sense unless you are paid extremely well.
This category of investments covers things that you buy that don’t produce anything but that you hope someone else will pay you more for later on. The classic example of this is gold. Warren Buffett muses that if you take all the gold in the world and put it in a cube, it will be measure approximately 70 feet by 70 feet by 70 feet, or 300,000 metric tons. You can get a ladder and sit on top of it, and say you’re sitting on top of all the gold in the world, but you are not doing anything; all you are doing is hoping that someone else will pay you more.
Betting on gold requires betting on not just how scared people are now, but also how scared people will be 2 yrs from now. This is a perverse kind of thinking that can be very difficult to master. As Charlie Munger quips, it seems peculiar to buy an asset that will go up if the world is going to hell. Like Keynes alludes to in Chapter 12 of the General Theory of Employment, Interest and Money, the game is not to pick out the most beautiful woman, but to pick the woman other people think is the most beautiful.
Investments with Intrinsic Value
This is the type of investment you want to focus on to invest like Warren Buffett. The third category of investments are investments that you value based on what it will produce – for example, you might buy a windmill because of the electricity that it can produce. With these investments, you decide how much to pay based on how much you think the asset will produce over time. This is the type of investment that appeals to Warren Buffett and Charlie Munger, for you make rational calculation of how valuable the item is.
When Warren Buffett bought Lubrizol, he didn’t want to run around and get a quote on it every week; he doesn’t care if the stock exchange closes for a few years. What he is looking for is what he thinks can be delivered from the productive assets that Lubrizol owns.
Over time, it is a good bet that good-producing businesses will outperform something that does not produce anything.