Many billionaire investors follow a value investing approach.
Some of the best-known billionaire investors follow one common approach: They are value investors. People like Warren Buffett, CEO of Berkshire Hathaway (ticker: BRK.A, BRK.B); Seth Klarman, CEO and portfolio manager of Baupost Group; Mason Hawkins, founder of Southeastern Asset Management; and Mario Gabelli, CEO of GAMCO Investors (GBL), are a few value investors. They may have taken different paths to make their fortunes, but there are similarities in their value investing strategies, says Trip Miller, founder and managing partner of Gullane Capital Partners. "Investing is not necessarily an exact science from investor to investor, but you see a lot of common themes," he says. Here are nine common traits of billionaire value investors.
They know markets aren't always efficient.
Value investing rejects the idea that securities are properly priced and markets are efficient, says Andrew Whalen, CEO of Whalen Financial in Las Vegas. One area where this inefficiency occurs is when unprofitable companies are highly valued. That's based on hopes of future profitability, rather than securities analysis, he says. Buffett is best known for this theory, but Whalen says he learned it as a student of Benjamin Graham, widely known as the father of value investing. Graham wrote two classic value investing books, "Securities Analysis" and "The Intelligent Investor." Buffett called the latter the best investing book ever written, Whalen adds.
They seek intrinsic value.
Billionaire investors like Hawkins and Buffett look for companies with strong balance sheets such as those with little debt, which are trading far below their intrinsic value. A company's intrinsic value is calculated through fundamental analysis and not market value, Miller says. They also look for companies that can grow over time, which can confuse some investors who think value investing precludes growth. Value investing is not get-rich-quick growth. The best of both worlds is to buy a company that is growing but with share trading at a discount to its fundamental value, Miller says.
They seek a margin of safety.
The concept of margin of safety goes back to intrinsic value and is most associated with Klarman, who wrote the book, "Margin of Safety: Risk-Adverse Value Investing Strategies for the Thoughtful Investor," detailing how it works. Colin Hickey, partner and director of client investment advisory at Forbes Family Trust, says investors who employ a margin of safety tend to only purchase securities when the market price is greatly below the intrinsic value to minimize risk of loss. Investors can use margin of safety based on their risk preferences, and it can be applied to any type of investment.
They know their circle of competence.
Both Buffett and his business partner, Charlie Munger, vice chairman of Berkshire Hathaway, often talk about a "circle of competence," Miller says. A circle of competence is the subject area, in which the investor has some skills or expertise, and it builds on the idea that investors should buy what they know. It takes discipline to follow this principle. "Discipline is having the willingness to say, I don't know this, I don't have an edge, so I'm going to pass," Miller says. "We don't have to invest in everything." Investors can limit their risk by concentrating on investing in industries they understand.
They look for companies with wide moat.
Along with looking at the intrinsic value of companies when building a portfolio, these high-net wealth individuals consider what advantages the firms have to keep competitors at bay, which will help ensure their longevity. Buffett calls this a company's economic moat. "If you own a basket of securities that have strong competitive advantages that are consistently reinvesting in their capital into research and development to further competitive advantages, and you have a good management team or a corporate board, that stock over time should reward you because of growth of the business," Whalen says.
Daniel Milan, financial advisor and managing partner of Cornerstone Financial Services, says value investors don't get caught up in headlines. When investors have done their research and found a company with a strong balance sheet and good management with stock trading at a discount, these investors focus on the long term and won't get distracted by market volatility. "Value investing at its core is a way to remove emotion and make fundamentally sound decisions," Milan says. "You concentrate on profitability." Mario Gabelli, CEO of GAMCO Investors is known for waiting years for an investment to pay off.
They buy at the right time.
Patience is not just buying and holding, Miller says, but waiting for the right time to buy and not overpay. Many of the top value investors have done their research on a company, a plan of when to buy and a disciplined plan to follow. "The hardest thing for investors to do is to sit on your wallet," he says. "But when markets retreat, you're prepared to react to take advantage of falling prices." Buffett famously bought Goldman Sachs Group (GS) and Bank of America Corp. (BAC) during the Great Recession, when banks' share prices were extremely low.
They don't time the market.
Timing the market is nearly impossible to do correctly, which is why billionaire investors like Gabelli, Klarman and Buffett focus on the idea of time in the market, not market timing. "The time value of money and compounding interest are two of the greatest things ever created," Whalen says, but it works only if investors leave their investments alone. It's like a farm, he says, using one of Buffett's common analogies. "You don't look at the value of a farm every year, you just make sure that it's yielding what it should be," he says on Buffett's comparison. There are years when it yields more or less, but over time, the farm's value should increase.
They diversify properly.
Diversification is important -- but do it properly. Retail investors can diversify by owning a simple mix of stocks and bonds appropriate for their age, goals and risk appetite. But don't over-diversify, Hickey says. "Peter Lynch, famous investor and former portfolio manager of the Fidelity Magellan Fund, was one of the first to use the term 'diworsification' as a way to describe inefficient diversification in a portfolio," he says. Too many investments can increase costs and fees, add layers of required due diligence, diminish correlation benefits and lead to poor risk-adjusted returns after fees and taxes, he adds.
Here are nine common traits of billionaire value investors.
-- They know markets aren't always efficient.
-- They seek intrinsic value.
-- They seek a margin of safety.
-- They know their circle of competence.
-- They look for companies with wide moat.
-- They're patient.
-- They buy at the right time.
-- They don't time the market.
-- They diversify properly.
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