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Berkshire Hathaway Inc. (BRK.B): How to Invest Like Buffett, Lynch and Soros

Berkshire Hathaway Inc. (NYSE:BRK.B)Some advisors like to tell you that the stock market is efficient, and that all the available information has been ‘priced in.’ Professionals have better, quicker access to information. You cannot compete, so you should buy a low-cost index fund.

But some investors outperform the market. And great investors, like Warren Buffett, Peter Lynch and George Soros have crushed the market. Buffett doesn’t rely on getting data a nanosecond before the market – he doesn’t have a computer in his office. It is said that his only use for a computer is to play online Bridge.

So how do these guys do it?

The Oracle of Omaha

Buffett started out as a value investor, buying companies with assets worth more than the value of their shares. Railroads were an early favorite as they had hugely undervalued properties on their balance sheets. Buffett bought, waited, and cleaned up.

As Buffett got better, he realized that the best way to value an investment was to look at how much cash it would generate. Businesses with a low capital requirement have an advantage over businesses with high capital costs. Buffett bought See’s Candy in 1971. It has significant value in its brand allowing it to generate high revenues relative to its costs.

Another favorite Buffett technique is to use share buy backs. He showed Katherine Graham at the Washington Post how to improve profitability by seven times. Then, through buying back 40% of the shares, he upped that to an improvement of ten times in the earnings per share.

The easiest way to follow Buffett’s investment style is to simply buy shares in his company, Berkshire Hathaway Inc. (NYSE:BRK.B). Buffett’s stewardship of Berkshire Hathaway is a masterclass in capital allocation. He trusts hand-picked managers of cash generative businesses to operate independently. The cash is dispatched to Omaha, to be recycled into further cash producing businesses.

Buffett’s major acquisition, GEICO perfectly reflects Buffett’s style. It does not require high capital and the insurance premiums generate cash float, which can be invested for high returns.

Let’s pick a company that has the attributes that Buffett values. Apple Inc. (NASDAQ:AAPL)

generates loads of cash. Its value is in its brand and in its innovative culture. It uses its surplus cash to buy back shares and it is currently undervalued by a skeptical market. Buffett famously avoids technology companies, but if he were to invest in them, I think Apple Inc. (NASDAQ:AAPL) would be right up his street.

Apple Inc. (NASDAQ:AAPL)’s price earnings ratio of 10 is low. If we ignore Apple’s holding of $143 billion in cash and securities it reduces to 6. By comparison, Microsoft has a ratio of 18, which is the NASDAQ average.

At this level Apple Inc. (NASDAQ:AAPL) is valued as a company with no future growth. This seems unreasonable for a company that spends $3.4 billion a year on research and development, has a history of innovation and a CEO promising new product releases later this year. Apple meets the Buffett test on three counts. It is a value play. It capitalizes on brand value to generate lots of cash. And it enhances shareholder value through buy backs.

The Mutual Maestro

Peter Lynch earned his reputation by making an average annual return of 29% for 13 years when he managed the Fidelity Magellan Fund. Lynch’s approach to investing was based upon intimate knowledge of the business, common sense, and an independence of mind that took him into areas that others ignored.

Before investing in a company, he would patiently spend time finding out as much as could, often visiting and discussing the company’s prospects with management. Lynch used his everyday experience to unearth investment prospects. If he was a customer of a company that provided good service, or if he happened to see a long queue of customers outside a new restaurant, he would start investigating the business with a view toward investment.

He invested in Japan, making good returns before the rest of Wall Street woke up to the opportunity. Like Buffett, Lynch didn’t get involved in day trading, short term moves or derivatives. He felt that he got his best returns from a stock after holding it for four years.

Unlike Buffett, Lynch kept a large portfolio of funds, categorizing his investments into Slow Growers, Stalwarts, Fast Growers, Cyclicals, Turnarounds and Asset Plays. His book ‘One Up on Wall Street’ is full of amusing one-liners all apposite and valuable.

What would Lynch invest in today? He loves fast growers and one of his early favourites was Taco Bell. A similar company, Chipotle Mexican Grill, Inc. (NYSE:CMG), might attract Lynch’s attention.

Lynch could experience Chipotle Mexican Grill, Inc. (NYSE:CMG)’s high quality food as a customer and he would be impressed by the quality focused management. On the financial side, Lynch places a high priority on a strong balance sheet, and Chipotle’s strong cash flow and lack of debt pass the test with flying colors.

Lynch writes that he likes fast growers that “duplicate the winning formula mall by mall, city by city … the expansion into new markets results in the phenomenal acceleration on earnings.”

Chipotle Mexican Grill, Inc. (NYSE:CMG) can still add many more stores domestically and is expanding into the new ShopHouse market. With just a handful of international locations there is a huge opportunity for growth overseas. Lynch would love it.

The Hungarian Seer

George Soros fled the Nazis and started a career as a stock broker in London, later moving to Wall Street. His reputation was made when he made billions betting against the Pound, forcing the United Kingdom to exit the European Monetary System at a massive cost to the British tax payer.

The tussle with the UK gave him a somewhat sinister reputation, as he was perceived as seeking personal gains without regard to the wider damage caused. But Soros did not create the economic climate; he was just smart enough to take advantage of a situation before the rest of the market.

Soros’ style is the antithesis of that employed by Buffett and Lynch. Whereas they look at long term investments in great businesses, Soros likes to trade on momentum shifts in the market, using a system he calls Reflexivity.

Soros has a massive collection of highly placed contacts widely spread around the world. He uses his informed global viewpoint to make uncannily accurate predictions of market changes. Then Soros makes huge bets on currencies, interest rates and securities.

Soros is famous for his huge investing coups, but he has also had massive disasters. He shrugs these off with a cool detachment, cuts his losses and waits for the next opportunity. In other circumstances, Soros could easily have been wiped out and would never have risen to fame.

Unless you have knowledge of the occult and global connections at the highest level of government, I would not advise you to emulate George Soros.

The Bottom Line

Peter Lynch and Warren Buffett have both been extremely successful following a simple approach that any investor can emulate – stick to the fundamentals and treat your investment as ownership of a business. George Soros has become successful using an approach that is impossible to emulate – predicting market moves and trading aggressively.

Curiously, many amateur investors appear to be taking the ‘impossible’ route, by trying to predict the market and making frequent trades.

Perhaps we should pay more attention to the simple lessons of Buffett and Lynch.

The article How to Invest Like Buffett, Lynch and Soros originally appeared on and is written by Ian Richards.

Ian Richards owns shares of Berkshire Hathaway, Apple, and Chipotle Mexican Grill. The Motley Fool recommends Apple, Berkshire Hathaway, and Chipotle Mexican Grill. The Motley Fool owns shares of Apple, Berkshire Hathaway, and Chipotle Mexican Grill. Ian is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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