Warren Buffett’s Four Pillars: The Ultimate Guide to Smarter Investing

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2:21And I've linked to them before on accident and other people have to, it's, it's, it's kind of a sham. So you really have to be careful on the internet when it comes to industry reports, um, how you gauge how reliable someone else. Love this podcast because it crushes your dreams and getting rich quick. They actually got me into reading stats for anything. You're tuned in to the Investing for Beginners podcast. Led by Andrew Sather and Dave Ahern. Step-by-step premium investing guidance for beginners. Your path to financial freedom starts now. Starts now. All right, folks. Welcome to Investing for Beginners podcast.

3:06Today, we're going to talk about what we can learn from Warren Buffett's four pillars of investing. So if you live under a rock, you may not have heard, but Warren Buffett recently announced that he's going to be going air quote quiet. He released his last missive to us before he steps down. He wrote a letter for Thanksgiving and it's available online and it's a great letter. But we thought we would talk maybe about some things you can learn from Warren Buffett and how these ideas can make you a better investor. So he has four pillars of investing that we're going to kind of talk through. So I'll go ahead and list them and then we'll go ahead and start chatting.

3:46So the first one is the quality of information. The second one is consistency of earnings growth. Number three is finding opportunities around your investment style. And the fourth is the importance of management and how to find good managers. So let's go ahead and dig into these. So when you think of quality of information, how is that important to us as investors? I think it's super important. And I think it's becoming more important the more and more technology and access there is. One of the great developments that we've seen in the stock market and in the investment world has been the democratization of finance.

4:26And finance has become so much more accessible in the United States. and hopefully over the next couple decades it will also be that way in the rest of the world. But with that has come just a flood of information. Some of it good, but some of it bad. And just because information is commonly accepted or a lot of people are repeating certain information doesn't make it quality information. So you can give yourself an edge over the consensus simply by having a higher standard for the quality of information that you are using when you make these decisions. So I would be curious from your perspective, and I kind of want to flip it on you for a second, what would be some bad quality sources of information that investors should avoid or at least take with a huge grain of salt?

5:19I think probably the first thing that I would consider would be any sort of information you get from a friend or a family member or somebody you work with. If they come to you and tell you, hey, I heard about this great company or I just read about this great stock and they do this, this, and this, and this, that may be okay for just getting introduction to a particular business, whatever the company may be. But if you're going to go invest on that and that alone, you're setting yourself up for a really hard potential fall. So that would be probably the first thing I would look at. The second thing to consider would be a lot of information that comes to you on social media is not vetted or is repeated, repeated, repeated, repeated, repeated from somebody who started the chain becomes viral idea.

6:21and if you don't verify it, then it can be a problem. And I'll give you an example. This happened to me on Twitter a while back. I was looking for some content to post and I found an image that looked like some information from Ben Graham that was written by Ben Graham. And I was like, oh, all right. And the person that I copied it from, I was going to give them credit for it and I did give them credit for it. But I thought that they had done the research on the information. And so I just dumbly just copied it and put it in there. Lo and behold, Jason Zweig was the one who wrote the copied picture that I wrote.

7:04And I was crediting Ben Graham, not Jason Zweig. And he somehow saw it and sent me a message saying, hey, that's a mistake. You need to check your resources and whatnot. I took it down immediately and apologized. But that was, to me, was a very important point. Just because you see an account that you trust saying something doesn't necessarily mean that the information is right. I'm not saying it's always going to be wrong either, but it will do you five minutes of due diligence will put you in good stead. So those are two places I know. So the media can be sometimes suspect, but those two are probably the two highest ones for me.

7:52What about anything stand out for you? I think you covered it. Social media can be very insightful at times, very inspiring at times, but also you can potentially have false information. So like you're saying, and I think some of the hallucinations are happening more and more frequently. So we just have to be careful. Yes, for sure. So to counteract that, where would you go to try to make sure that you're receiving quality information? We can go back to Warren Buffett and hear what he had to say about it. He was a big proponent of just the annual reports and the quarterly reports. He did not spend time with anything that Wall Street produced, which I thought was kind of funny.

8:38He was very adamant about just the annual reports and the quarterly reports. So that worked for him for the type of businesses he invested in. That might not work as well for something where the numbers are driven because of technological advancement, for example. But he very intentionally picked a lane where you can look at the big picture, you look at the big picture numbers, and you get a sense of some of the stability and the developments of certain businesses. And so to me, that is the best place. That is, you go to the source and you go to the annual report and you see what is in there. And to me, there is no better alternative than that.

9:23that's that's easily the first place that you should start when you're trying to gather information and to your point he spends his day reading annual reports from the company and he will read not just a company he's interested in but also he will read all the companies around it to get a sense of the of the industry and who are who are competing against those companies and so he will do a lot of research around that and do a lot of reading and that's really how he you know he he's obviously like the Michael Jordan of investing like he's got this incredible memory and it retains a lot of the information that he you know acquires and so he you know like everything else it compounds so the more he learns about Apple the more he's going to learn about competitors to Apple?

10:16And that just helps him make more informed decisions. And that's part of why he's been so successful. Yeah. Going to the source has so many benefits, but one great example would be if you are familiar with the financials of a company. So if a company is in three segments and maybe one company is only 2 % of their business, then you can basically filter out all of the noise around that 2 % of the business and understand, okay, this doesn't really affect my investment in this company. Sure, it generates headlines. Sure, Waymo is an exciting service, right? But what are the revenues and what is it producing?

11:01And is that going to actually make an impact over the investment time horizon I have for a stock? I don't want to beat up on straw men, but it does feel like people get tangled up in arguments over companies on stuff that really doesn't matter if you just would have looked at the annual report and realized that there's actually this driving the business and everything else is noise. How do you feel about any sort of tangential sources of information, like industry reports or maybe listening or reading things that experts will have? So people that maybe you have vetted and you feel like these people know their stuff in a particular industry because that's what they focus on.

11:45How do you think about that? Yeah, it's definitely a sliding scale.

11:53Who cares? These people suck. There are some industry reports I put in quotes that is, if you actually dive into it, it's a bunch of garbage. They're coming up with fake numbers and they're putting fake projections. And I've linked to them before on accident and other people have too. It's kind of a sham. So you really have to be careful on the internet when it comes to industry reports. How you gauge how reliable someone else's research is, I think you really have to evaluate the person. And to your point, like you're saying, Dave, if somebody has proven that they have the knowledge, the incentives are aligned, they are doing things and uncovering research because they want you to benefit the reader as well as it benefits them as well, I think that is a huge factor.

12:43And then just showing that expertise through their work is a great way to be able to evaluate something. And to go rip on social media again, I think a decent filter, and this is just my opinion, this isn't the opinion of Investing for Beginners podcast, but an anonymous face on Twitter, I am super way more skeptical of than somebody who's willing to put their face and their name out there and actually take ownership of their ideas. I wholeheartedly agree, especially not only if it's an anonymous name, but there is no picture at all. Like they haven't even bothered to put a face, a fake of anything, you know, at least, you know, if somebody puts a, you know, I don't know, a picture of Warren Buffett on there, then it's like, okay, you know, at least they tried.

13:34But, you know, the people that are espousing opinions that are anonymous names and also like anonymous pictures, like they literally, way you just see the little blue shape of a person's head and that's it. Okay. That's, that's, that's, that's a hard no. Like, like anything else, you have to do some, you have to do some vetting. You have to do a little bit of digging to find there. And there are good people out there. You just, you got to make sure you try to find the ones that are responsible and reputable and, and you will, and they can be very helpful. So let's, move on to the next pillar, which is consistency of earnings growth.

14:17So what does that mean to you? This is important because we can get so wrapped up in the numbers and I'm guilty a lot, but a lot of the numbers that investors use is very related to what has a company done for me lately. So what are the earnings lately? And that sounds like a great idea, but it can get you into trouble if you are looking at companies where the earnings is not consistent. I'm not going to do it justice, but if you are serious about stock picking and things like that, I think it's worth you doing the time investment. But if you learn about the difference between compounded returns that are smooth versus those that are up and down, you'll have...

15:07Basically, the way the math works out is if a company's earnings really tank and they tank often, and then when they rebound, the rebound sounds great. Oh, we rebounded earnings 300 % or something. But depending on how much the earnings tanked, you're actually over the long term, they keep doing that. You're not actually getting good compounding because the losses of earnings really take away from the compounding. And it works the same with stocks, by the way, which is why what Buffett has done is so brilliant. And you only really see it play out over the decades that he invests. But that is just the math of compounding where these swings and these big drops in growth, they take a big backseat and they do not beat just slow, steady, consistent because the consistency compounds.

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18:32He mentioned that. One of the strengths of companies that he looks for was this durability of earnings. And it goes back to what Buffett has taught us about the consistency of earnings growth. because a lot of that tends to relate back to this idea of moats or competitive advantages. And companies that have a competitive advantage for a long period of time will be able to grow earnings for a long period of time. And one of the things that Buffett has really loved about the companies that he's invested in is that none of us can predict what's going to happen tomorrow, let alone five or 10 years from now.

19:12But one of the things you can do if you have companies that have competitive advantages that are strong enough that they can compete and be a consistent grower over a long period of time, then you can have some success of predicting how well a company could do in the future. is one of the benefits of a company like a visa or mastercard their earnings are like clockwork and it's so it's easy to project how well it'll do five or ten years from now now will that be right you know that the time will tell of course but based on what they've done in the past it's easy to look at costco it's another one you know companies that the buffet has had huge stakes in coca-cola and american express have all both had very consistent strong earnings over a long period of time.

20:04They're durable. And so he loves those kinds of companies and we all should. It's really hard. It's really stressful to invest in companies that do not, that you're always worrying about what's going to happen the next quarter. Is this going to be the quarter that finally ends? I was talking to Nick from Chips Stock Investor yesterday, a little bit about NVIDIA. And that was one of the things I mentioned to him is like, that's one of my concerns about the company is when is it going to end i'm not saying it's going to i'm not trying to bash on nvidia so don't come at me um but it is it is a narrative in the market right now about what's going to happen when is that when is this train ride going to end and so that's why buffett talks about these consistency of durability of earnings and it all revolves around a moat and the strength of the business model that these companies exhibit.

20:59And the more you understand the business model and the better you understand the competitive advantage this company has, the easier, air quote, easier it will be to try to predict how you think the company will do going forward. Yeah, you're absolutely right. You're going to be right more times than not if you can do that. And that's the best we can hope for. So what are some of the ways that we can look at historical data and try to find those companies with sustainable earnings growth? Well, I think the easiest way to do it, if you will, is to try to look at a longer time horizon. So whether it's just looking at a quarter or two is not going to get you to the promised land.

21:47You got to look at 5, 10, 15, 20 years if it's available to be able to see how this company is done over a long period of time. And not just looking at one aspect of the growth. Obviously, revenue growth is important, but you also want to look at the growth of the margins of the business and how well those are expanding. Those can be fantastic indications that the company has pricing power. It has operating leverage. It has something that people want. It's popular. And if they can do that continuously over a long period of time, that means management has figured out a way to sell a product that people want.

22:26They can do it profitably and they can keep their finger on the pulse of the business and keep it going over a longer period of time. So what did I miss? I mean, that pretty much hits the nail on the head. We could go a million different directions with it, to be honest. So I like that. Is there anything else you think? I mean, maybe just touch on the modes briefly and then we can move on to the next pillar yeah i would i would when you're looking at a company try to determine what gives it a business strength and there's there's five or six of them that you can look at but i'll just touch on two or three of them that are probably the most common network effects switching costs and scale benefits so network effects basically if you understand a company like a visa or mastercard or even meta the stronger the network is, the stronger the business is.

23:15The more people that are on the network, the stronger the network becomes and becomes this self-fulfilling flywheel that helps make the business stronger. If you look at switching costs, the more entrenched a business becomes in their customers' lives or processes or businesses, the harder it is to switch. You think about banks. Banks, to me, is always the perfect example. I've said this before. Or people have longer relationships in a lot of cases with their bank than they do with their significant other. And that's a lot in part because it's such a pain in the butt to move your accounts from JPMorgan to Citibank, for example.

23:52So switching costs are a very strong moat. And then scale benefits. The larger a business is, the more discounts or more impacts and benefits they can pass on to customers. And the easier they can make it for customers to save money. Walmart is a perfect example of this. Amazon has also excelled at this as well. And so those are three of the main ones, but there's six or seven main ones, but there's lots of different nuances to all of these. Yeah, totally. And those are some great examples of companies that really exemplify that. Yeah. The next one is finding opportunities around your investment style.

24:32So Buffett kind of, I guess, the way I interpreted it, he had three main ways that he kind of invested in. Those were generals, workouts, and control situations. And I think instead of maybe focusing on those, I think I would probably rather discuss what your investment style is, how you figure out what that is to work for, and then how you find things that fit within your circle of competence. Yeah. I mean, he famously changed from a deep value kind of investor to more of a long-term quality investor once he met Charlie Munger. And so you do wonder how much of that was driven by kind of seeing the limits to size, what happens with scale.

25:25So, yeah, I mean, I think for me personally, I know that I've been a poker player for a long time. Didn't quite play when I was coming out of the womb, but I know my grandfather started me really young. And so I've always been big on math. My mom actually did get me, I think, in the womb with the math part. But always been big on math, always been big on numbers and probabilities. of these. And I just love playing the right cards at the right time and making the right bets at the right time. That's a big poker thing. And so that's always appealed to me personally as an investor. And so I've had to decide, and it didn't happen on day one.

26:09I obviously gravitated towards strategies that prioritize numbers, but I had to decide as I matured as an investor to focus on companies where that would be an advantage to me rather than a hindrance. The numbers don't mean much when you are going IPO and you have a company with big dreams, big ambitions, big story. They're just a baby. You wouldn't measure a person's ability to jump when they're three months old to figure out if they're going to be in the NBA or not. You'd probably have other factors than just their sole numbers at that time. So IPOs, gross stocks are in that similar camp. And for me, I realized that the numbers approach can work, but I also had to stay very diversified.

27:03It is not something that generally would be a great idea to put half of my portfolio in something just because I really like the numbers because that's making too big of a bet. That's going all in in poker on something where your odds aren't as good as maybe you think. And that's one of the challenges with the stock market. It's not just a deck of cards. There are many factors where sometimes the numbers work out. And other times in other businesses and other industries and other innovations, the numbers really get mixed up. And so you have to have a lot of experience and humility. And I believe strongly that the market goes through these cycles.

27:51That sounds obvious, right? Obviously, there's bear markets and there's bull markets. But I also believe there's cycles in what things are popular with investors. So sometimes the numbers are the hot thing and sometimes the stories are the hot thing. And you can really apply that to so many nuances around investment styles. And so to your point, you do have to find what works for you because if you keep chasing whatever is the hot investment style of the day, you're going to be constantly chasing after your own tail and never actually bearing the fruits of your own personal strategy. So huge long soapbox for that.

28:32But that's kind of some of the takeaways I've had and some of the realizations I've had as I've been a stock picker over the years. I'm curious about your investment style and has that changed over time as well? Oh, it most certainly has. I do want to say one thing. I am super jealous that you know how to play poker and have been good at it and understand the whole odds behind everything. I will freely admit that I am the world's worst poker player. And if people want to make easy money off, I am that, you know, what is that saying? If you ever wonder who's the sucker to table, you're the sucker.

29:11I'm the sucker. So I am, I am not good at poker at all. So don't tell those NBA players. Yeah, right. Ouch. So yeah, my, my investing style has definitely evolved. uh, since we, since we started all this. And as I've learned more, uh, a lot of it has to do with the, when I first started for me, numbers were very important and they still are, but they also, uh, gave me a, they, they provided me with a security blanket. Like I could look at the numbers, I could try to understand them and it would make me feel like I was air quote, more in control of decisions I was trying to make based on just looking at what a number would tell me, whether it's the gross margins are growing or the return on invested capital is improving.