To most, Warren Buffett’s investment strategy is a mythical ideology.
It’s astounding to note that a $1,000 investment in Berkshire Hathaway—Buffett’s investment company—in 1965 is now worth $15.3 million !
(adjusted for inflation with dividends included, at a compounded annual gain of 20.8 percent).
In comparison, the same amount invested in the S&P 500 would be worth a paltry $112,341.
He is a genius to say the least, and probably the world’s greatest investor.
But how does Buffett, the Oracle of Omaha, do it?
And how do his principles apply to Australian property investing?
A value investor, like a bargain hunter in a flea market, searches for companies or assets that are currently out of favour with the market and are worth much more than their current valuation.
The securities are undervalued and are trading below their intrinsic worth when they are snatched by the investor. The concept provides substantial profits to the investor once the market inevitably re-evaluates the stock and corrects its price to fair value.
It also protects their downside should things not go according to plan and the business falters.
An investor should act as though he had a lifetime decision card with just twenty punches on it.
Although the safety net of purchasing underlying companies for much less than their worth is the central theme of most Graham’s students, Buffett uses a more pragmatic approach by considering the overall performance of a company.
Its quality and capability to generate earnings are far more compelling to him than capital gains and when he invests in a company, he intends to hold the stock for a long term or indefinitely.
This approach and his adherence to personal frugality have made him immensely wealthy beyond an average man’s wildest dreams.
This value-oriented investing technique can also be employed by property investors. Real estate assets have an underlying intrinsic value that is always determined through vigorous evaluation and analysis.
The opportunity for profitable investments therefore often arises when the intrinsic value of an asset is above its purchase price. Such insight, however, requires one to familiarize themselves with the tenets of Buffett’s investment philosophy.
Here we take a look at some of them and how they can be applied in the world of property investing.
Return on Equity/Return on Investment
A stock’s return on equity is a measure of its profitability. It reveals the rate at which shareholders are earning per share and Buffett always looks at this metric to judge a company’s performance in comparison to others over a period of time.
In property investing, dividing the purchase price of a house by the rental income you could expect to earn over a period of a year can paint a good picture of the property’s ROI. With this you can compare with other properties on the market and the historical values in that market.
Low Debt to Equity Ratio
Another feature that Buffet considers highly is the debt/equity ratio. Buffett prefers shareholder’s equity to be the main driver of the growth of earnings rather than debt. To that end, he opts for companies with a small amount of debt.
The same principle is applicable to property investing. Avoiding incurring large amounts of debt to purchase a property as this increases the volatility of earnings and adds large interest expenses, thus limiting the amount of money that reaches your coffers.
Margin of Safety
This is where the magic is. Ascertaining whether a company is undervalued is the most an important skill for a value investor. Buffett calculates the company’s intrinsic value based on a range of factors, including fundamentals such as revenues, earnings and assets, and compares it to the company’s current market capitalization.
If the intrinsic value is higher than the market capitalization by not less than 25 percent, Buffett believes that the company has value. The essential task for the property investor is to determine the intrinsic value of the investment and capitalize on the inefficient market mispricing.
Value investing requires being able to hold a position regardless of prevailing market conditions. This sentiment is echoed in one of Buffett’s famous quotes:
If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.
The basic principle is relevant to property investing—buy at the right time and at the right price and hold out for your target price. Hold forever if it’s a winning piece of real estate.
This applies very well to Australian property prices; historically they have doubled almost every 10 years over the past 100+ years. This is a proven way for winning and growing your wealth.
Here’s a brief checklist on what you should look out for when selecting Australian property:
- Make sure you buy from a reputable property developer (Buffet buys blue chips stocks)
- If possible, select a landmark development that is unique (Buffet selects stocks with a strong competitive advantage)
- Choose a location that has good prospects for growth (Buffet selects stocks with good growth potential)
Buffett is a great example and ambassador of the investment discipline. His basic ideas are timeless and proven. If you want to improve your property investing returns, it doesn’t hurt to apply his proven strategies.
**Special offer for Property Hunter readers:
Would you like help to create a personalised, Buffet-style investment plan for investing in Australian property? Contact me by email or phone and I’d be happy to create one with you for free!
Photo Credit: Warren Buffett by Forbes
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