The Road to the Oracle of Omaha: The Evolution of Buffett's Investment Philosophy —— Part 1

Looking back on Buffett's growth journey, you'll find that his investment philosophy shows a very clear trajectory of phased evolution.

The division of Buffett's investment philosophy development stages is generally categorized as: the partnership company stage as the early period, from taking control of Berkshire Hathaway to the late 1980s as the middle period, and from the 1990s to the present as the late period. This division is based on the organizational form and operating model of the company, which has some merit, but it's not entirely accurate when strictly examining the evolution of his personal investment philosophy.

My personal opinion on the division is as follows:

First Stage (Early Period): 1949-1971 (ages 19-41). Mainly concentrated in the 1950s and 1960s. The investment style was Graham's margin of safety method, later termed "value investing" by others, while Buffett jokingly called it the "cigar butt" investment method of buying only cheap goods.

In 1949, at 19, Buffett first read Graham's classic "The Intelligent Investor," and was immediately captivated. Buffett's roommate Wood said, "It was like finding God for Buffett." It's entirely reasonable to mark this year as the beginning of Buffett's early investment philosophy formation.

On July 17, 1970, Buffett wrote in a letter to Graham, "Before this, I had been investing with my glands instead of my brain." Buffett himself even compared this experience to "Paul on the road to Damascus," and he learned the philosophy of "buying a dollar for 40 cents" from it. From then on, the philosophy of "margin of safety" became the cornerstone of Buffett's investment thinking.

Several events that occurred after this played important roles in pushing Buffett's evolution:

1950: Buffett formally "became Graham's student" at Columbia University's graduate school.

1954: Buffett joined Graham-Newman Corporation, working for Graham.

1956: Established his first partnership company, starting his entrepreneurial journey.

1959: Began to meet Charlie Munger, and they carried out a series of collaborations in the 1960s.

1962: Buffett started buying Berkshire stock, became the largest shareholder in 1963, and officially took over Berkshire in 1965.

1967: Buffett purchased National Indemnity Company for Berkshire for $8.6 million, entering the insurance industry for the first time.

1969: Buffett dissolved his partnership enterprise to focus on managing Berkshire.

During the partnership enterprise period, Buffett's investment methods were initially divided into three categories based on characteristics, later developed into four. In his January 1962 report to partners, Buffett divided his investment methods into three categories:

Generals: Undervalued stocks. The largest proportion of investments.

Workouts: Investments where the price depends more on corporate management decisions than supply and demand relationships between buyers and sellers. Corporate actions affecting investment prices include mergers, liquidations, reorganizations, spin-offs, etc. Unrelated to the Dow Jones Index performance.

Control: Either controlling the company or buying a significant number of shares to influence corporate management decisions. These investments also have little relation to the Dow Jones Index performance.

The first and third categories can transform into each other. If the price of a "General" lingers at a low point for a long time, Buffett would consider buying more shares, evolving it into a "Control"; conversely, if the price of a "Control" rapidly rises within a few years of purchase, Buffett usually considers profiting at the high point, completing a beautiful "Generals" type investment.

In his January 1965 report to partners, Buffett divided the original first category, Generals, into two: Generals-Private Owner Basis and Generals-Relatively Undervalued.

Generals-Private Owner Basis: These are undervalued stocks, small in scale, lacking appeal, and ignored. Their price is far below the value (intrinsic value) of the company to a private equity investor. If the price remains undervalued for a long time, it can be transformed into Control.

Generals-Relatively Undervalued: These refer to stocks that are priced lower relative to companies of similar quality. Although undervalued, they are usually larger in scale, less significant to private investors, and cannot be transformed into Control.

As early as 1964, Buffett noticed that Graham's strategy of buying cheap stocks had issues with value realization, was not perfect, and such investment opportunities were becoming scarcer as the stock market rose. The fourth category of investment, Generals-Relatively Undervalued, added by Buffett in his January 1965 report, can be seen as a new exploration. However, it was still in a quantitative change stage and had not completely broken through Graham's investment framework. The best case of this type of investment was in 1964 when Buffett invested 40% of the partnership's funds in American Express during the "salad oil scandal," holding the shares for 4 years. In the following 5 years, American Express stock rose 5-fold.

As Munger said, the experience of working under Graham and the huge profits made it difficult for Buffett's brain to break free from such a successful way of thinking.

In 1969, Buffett was greatly inspired by reading Fisher's "Common Stocks and Uncommon Profits." But it was Charlie Munger who truly helped Buffett break free from Graham's ideological constraints and complete his evolution. Munger had a keen observation of the value of an advantageous enterprise, and he further concretized Fisher's company characteristic theory. "Charlie pushed me in another direction, rather than just suggesting buying cheap goods like Graham did. This is the power of his thinking; he expanded my horizons. I evolved from an ape to a human at an extraordinary speed, otherwise I would be much poorer than I am now."

In summary, it was only when encountering the problem of value realization that Buffett recognized the limitations of Graham's philosophy of "buying any company regardless of its essence," and began to integrate Fisher and Munger's theory of outstanding enterprise expansion value into his philosophy.

Second Stage (Middle Period): 1972-1989 (Ages 42-59)

On January 3, 1972, following Munger's advice, Buffett acquired See's Candies for $25 million. This marked the beginning of Munger's continuous push for Buffett to move towards paying for quality.

As See's Candies thrived, both Buffett and Munger realized that "buying a good business and letting it grow freely is much easier and quicker than buying a loss-making business and spending a lot of time, energy, and money to support it." The formation of this investment philosophy marked Buffett's "evolution from ape to man."

Buffett combined the ideas of Graham, Fisher, and Munger to gradually form his own style. This evolutionary stage can be corroborated by the words of Buffett and Munger. In 1997, at the company's annual shareholders meeting, Munger said, "See's Candies was our first acquisition based on product quality." Buffett added, "If we hadn't acquired See's Candies, we wouldn't have bought Coca-Cola stock."

The notable characteristics of Buffett's investment method during this stage were reducing arbitrage operations and investments in cheap stocks, increasing control of excellent businesses, and using insurance float for long-term investments in quality company stocks:

Acquisition and permanent holding of excellent businesses: such as See's Candies and Nebraska Furniture Mart.

Permanent holding of a few "inevitably so" great company stocks: such as The Washington Post, GEICO, Coca-Cola, etc.

Long-term investment in some "highly probable" excellent company stocks.

Medium-term fixed-income securities.

Long-term fixed-income securities.

Cash equivalents.

Short-term arbitrage.

Convertible preferred stocks.

Junk bonds.

In the first stage, Buffett's investment philosophy and role were essentially that of a Graham-style "private equity fund manager." In the second stage, he transformed into a dual role combining entrepreneur and investor. He said, "Because I consider myself a business operator, I become a better investor; because I consider myself an investor, I become a better business operator."

This stage can be summarized by Buffett's words in 1985: "I am now more willing to pay a bit more for good industries and good management than I was 20 years ago. I used to look at statistical data alone. But I increasingly value those intangible things."

Third Stage (Later Period): 1990 to present (From age 60 onwards)

This stage begins in the 1990s. A more precise division could be from 1995 (age 65) to the present as Buffett's later period. Munger's words provide evidence: "After the age of 65, Warren's investment skills have truly reached new heights."