Warren Buffett's Value Investing Formula (For Dummies)

Value investing, originally coined by Benjamin Graham but popularized by Warren Buffett, is a long-term investing strategy that quite simply boils down to buying high-quality businesses when the stock price represents a solid discount to the business's intrinsic value.

Now, as I said, the reason that value investing gained so much traction, say over the past 50 years, is because Warren Buffett used this strategy to become the world's most successful investor ever, averaging 20% returns per year since 1965. That's approximately double the returns of the S&P 500 every year.

The thing that makes Warren Buffett's value investing approach so popular is that it's absolutely timeless. It always works, no matter the decade and no matter the market conditions. The strategy can be boiled down into four overarching steps:

1. Understanding the business.
2. Ensuring the business has a durable competitive advantage.
3. Making sure the management team operates the business with skill and integrity.
4. Making sure you only buy the shares when they're at a discount to intrinsic value.

Now, as a young adult, an Indian man by the name of Monash Price saw Buffett's success and decided to implement the exact same strategy. He learned pretty much everything there is to know about Buffett's value investing, then implemented it himself and, like Buffett, also achieved amazing returns.

Now today, Monash continues to manage money under the same Buffett value investing principles. He actually recently did an interview where he explained each step of this process and how new investors can implement this strategy themselves. So, in this video, we're going to use Monash's help to discuss exactly how a beginner investor can start their investing journey following Warren Buffett's four key principles.

So with that said, let's dive into it.

Chances are, as someone that's new to investing, these four pillars probably don't mean much to you just yet. Right now, you're probably wondering, "Well, hang on, how do I even start finding businesses to try and apply this strategy to?" Well, let's hear from Monash as to how he does it.

"Well, I mean, I think that the best way to approach this is kind of like as if you're a gentleman or lady of leisure. I'm curious about a lot of things. I'm very curious about a lot of different businesses and how they work. I'm always trying to, you know, I'm reading autobiographies or biographies. I read a few newspapers every day, the physical papers. You could do it digitally. If you run across interesting books or interesting people, understand them.

"I think what you're looking for is something that hits you like a two-by-four, an aha moment, where some company or some business you may be a customer of, but you've then studied it, and then you come up with some major, I would say insight into the business that most other market participants probably don't understand and/or don't appreciate. If that insight is meaningful and valid, that becomes a big edge, and you don't need that to happen even more than once a year.

"So that's the first step in this whole process—just first of all, follow your curiosities. There's no magic website to find the best stocks. Just stick to your interests initially, just be a sponge, and just learn about businesses that you find really interesting."

As Monash says, what you're really looking for is finding those little pieces of information about those businesses that can give you that spark, that aha moment, that makes you think there could be something to this. Maybe you saw a stat that shows that Facebook has way more users than any other social media platform. You might be curious and say, "I wonder if there's something to that."

You might be a car lover and see that Ferrari's profit margins are around 50%, whereas every other automaker is around 20%. Hmm, I wonder why is that? This starts to put businesses on your radar. But there is a trick to this method, and it's to always stay within your circle of competence.

Never go digging into areas that you just know absolutely nothing about, because that will absolutely catch you out. So how do you know what's in your circle of competence and thus what businesses you might be capable of understanding? You can have a really, really small circle of competence, but what is very important is staying within the circle—not even going to the edges, stay in the epicenter.

And, you know, to ask the question is to answer it. So if you're wondering if something is within your circle of competence or not, the answer is it's not in your circle of competence. Probably, I think at your ages, what is likely the most probable to be within your circle of competence are products and services that you use regularly.

Generally speaking, I think a good way to begin your journey in terms of understanding what businesses to look at is just look at all the products and services you consume. Do you go on YouTube? Do you go on Facebook? Do you use Google? Do you use an Apple iPhone? Use an Android phone? What brand of clothing do you wear? What kind of toothpaste do you use? That’s, I think, a starting point because, generally speaking, for a brand to come through and be something that you would trust and use is a very high bar.

So I think that's probably the simplest way to start tackling the circular competence issue.

So I 100% agree with Monash here. The easiest way to find businesses that you might be able to understand is by noting down the businesses that are already a part of your life. You know, do you use Facebook and Twitter? Do you shop on Amazon? Do you eat at McDonald's? Do you own a Google Pixel? If you note down where you spend your time and what you spend your money on, you will just naturally start to formulate a list of businesses that you already subconsciously understand reasonably well—businesses that, with, you know, just a little bit of reading up, they could end up very firmly in your circle of competence.

So that's how you start finding stocks that you'll be able to understand. And then from there, the next pillar of this value investing approach is ensuring the business has a moat.

So what the heck does that even mean? The moat is a very broad kind of shorthand for what gives a business an enduring competitive advantage. But the moat encapsulates things like a low-cost producer. Sometimes the moat is all about that you don't need to have as much markup as someone else, like kind of a Costco. You know, they're always going to be under everyone else's price, and that gives them a strong moat.

For the most part, it can be quite obvious if you just spend some time thinking about it. Let's say, for example, you use Instagram or Facebook. For example, you can form some opinion about the stickiness and how long those businesses could thrive and what would it take to unseat them.

You know, I mean, these are classic network effect businesses, and I think that if you cannot get to a point where something is a no-brainer where you have been able to convince yourself that this is amazing, it just passed, because, you know, we— even if you make one decision a year or two decisions a year or one decision every two years that's perfectly fine.

So, a moat is all about the characteristic that gives a business a durable competitive advantage. As Monash said, maybe a company is the lowest cost producer of something. Maybe they have the best scale and can offer products the cheapest, like a Costco. Maybe they have a huge network effect like Facebook or an inescapable ecosystem like Apple.

You can really start to think about why these businesses have become so successful. When you're looking for a moat, it should be pretty obvious. You know, if you're looking into some cheap smartwatch company because, I don't know, I wear their watch every day, but really this watch was just a Christmas gift from grandma and when all along you really wanted an Apple Watch, it's clear—this company is not going to have a moat.

But if you're looking into Coke because you love their drinks and you realize that despite there being plenty of brands of near identical cola drinks, Coke still manages to outsell all these businesses, you know, ten to one, then you might have discovered a moat there.

So, absolutely, when you do look into a company, you need to be able to identify that reason why they will stay ahead of the pack. It's a very, very important step of finding great companies and great investments.

So that's the second pillar. Then we move on to the management team. How do you know whether the management team of this company is going to make the right moves to continue to grow the business over time?

The simple way to evaluate management is simply look at the track record. What have they done over the last 10 or 20 years versus what they said 10 or 20 years ago? And that's pretty easily available. So, Warren and Charlie don't care so much about the projections of businesses making or projections the manager is making. What they care a lot about is what is the track record of that manager or management team.

It's fun to go back into a business; go back 10 years, 15 years, look at the nature of the business, look at what the manager was saying, and then look at what transpired. You know, did they underpromise and overdeliver? Did they overpromise and underdeliver? Are they competent or incompetent?

I think these things start becoming very apparent in most cases when you start looking at those things from a long perspective. Monash raises a good point here: when it comes to management, look backwards, don’t look forwards.

Because what you'll find is that every manager is predicting good times in the future. No CEO is going to say, “Look, we see revenue declining substantially over the next five years, and then I think we'll probably have too much debt, and yeah, look, we're probably going to go bankrupt.” Absolutely not! CEOs will always be optimistic, even if their business sucks.

So instead of listening to what they say now, look at what they've said in the past and whether they've hit that. The easiest way to do that is just start 10 years ago and open up their annual report. You know, in there you'll probably find some sort of future guidance.

If they say, “Hey, you know, we predict long-term revenue growth of 25% annually,” you know, just go and check whether they achieved that. For example, Elon Musk in 2006 said, "In short, the Tesla master plan is one: build a sports car; two: use that money to build an affordable car; three: use that money to build an even more affordable car; and four: while doing the above, also provide zero-emission electric power generation options."

Fast forward to today, they did every single step! They made the roadster, they used that money to make the Model S, then they used that money to make the Model 3. Oh, and by the way, they also started a solar and battery business.

So definitely, with management, don't look at what they're promising right now; judge them by looking backwards. Look at what they did promise and what the results were.

And then with that said, finally, that brings us to our last pillar of the value investing approach, and that is valuation. How do you figure out what you should pay for the shares of a business?

If a business is within your circle of competence, by definition, you know what their business is worth, and you don't need to do this precisely. Okay, I mean, let's say I take a business like Coca-Cola. What is Coca-Cola worth? Okay, I would say that it's likely that Coca-Cola's intrinsic value is probably more than 15 times trailing earnings. It might even be more than 20 times trailing earnings.

If Coke is offered to you at five times trailing earnings, it’s a no-brainer; it’s an aha moment! If it's offered to you at 12 times trailing earnings, we don't know. And once we get to "we don't know," you can take a pass.

This is a game with no call strikes. You just keep doing that all day. You basically keep saying no to almost everything, and what happens is that once in a while there are these aha moments. I think the key is that it has to hit you between the head with like a two-by-four where you just cannot ignore it.

I really like this explanation by Monash—once you really understand the business, how much cash it's generating, how quickly it's growing, you can make a reasonable prediction of what the business's future may look like. You might use a discounted cash flow model to estimate that, you know, the shares are probably worth about a hundred dollars now, and that's never a precise figure; it's always a rough estimation.

But from that, you know, if the share price is say $110, easy pass. You know, if it's $100, pass. Even if it's $90, pass—there's just too much uncertainty to know that you're getting a good deal. But if that company, if the shares are offered to you at say $20, as Monash says, no-brainer!

The trick as a new investor is to have the patience to wait for that opportunity because, honestly, they don't come around often, but that's okay! The best investors in the world might only make one serious investment every other year.

So the best way to pick winners is just to wait until those big moat companies that are right in your circle of competence are offered to you at a price where it’s clear—it's clear that you're buying the business when it’s very cheap. If you have any doubt, don't do it! You know, the best investments are usually very obvious to you.

So definitely watch out, be patient, and wait for that amazing valuation! But overall, guys, they are Monash Price's thoughts and opinions on the four key pillars of the Warren Buffett investing approach.

I hope you enjoyed this video. I hope it maybe taught you something, gave you a little bit of encouragement maybe if you're new to investing and wanting to get cracking on this investment strategy. If you did enjoy it, leave a like! If you found it useful, leave a like! I really appreciate it; it helps this video get shown to more people, so that really helps me out.

Now, if you did want to take that next step, and you're like, “You know what? You win, Brandon! I'm definitely in with this whole Warren Buffett monitor value investing approach,” and you wanted just an eight-hour course which just leaves no stone unturned— it just goes video one, video two, video three, all the way through understanding the business, moat, management, margin of safety, and valuation—then if you're interested, you can feel free to check out Profitful.

That's my business that I started. There's a full eight-hour course on there called Introduction to Stock Analysis. If that's something that, you know, takes your fancy, all of the profits that are made over on Profitful get reinvested into making better YouTube content as well. So that's a way that you can financially support the channel, if that's something that you're interested in, to help me make more higher-quality YouTube videos.

But overall, guys, that'll just about do me for today. Thank you very much for watching! Of course, subscribe to the channel if you are new around here. If you've made it to the end of the video, you know, definitely subscribe.

I do a lot of value investing kind of videos; it's definitely the approach that I subscribe to. So if you're interested, stick around, subscribe, like the video, as I said, and guys, that's it from me for today. Thank you very much for watching. I'll see you guys in the next video!