The unpredictable market: Lessons from Buffett on weathering financial storms

As I prepare for my first trip to Omaha for Berkshire Hathaway’s annual meeting in May, I read Warren Buffett’s latest investor letter with interest and a touch of sadness. I admire him and Charlie for the clarity and tenacity of their investment philosophy and their dedication to creating and sustaining shareholder value. 

As he says in his letter, at the meeting in May, Warren will be on stage without Charlie for the first time in decades, marking the end of an exceptional partnership.

These are my key takeaways.

Invest in high quality businesses

Our goal at Berkshire is simple: We want to own either all or a portion of businesses that enjoy good economics that are fundamental and enduring. Within capitalism, some businesses will flourish for a very long time while others will prove to be sinkholes. It’s harder than you would think to predict who will be the winners and losers. And those who tell you they know the answer are usually either self-delusional or snake-oil salesmen.

To be honest, you don’t even need to think back to September 2008. If you are an investor in technology companies, the year of reckoning hit in 2022 when we saw the returns of technology companies decimated, with the Nasdaq falling 35% from November 2021 to December 2022. And while many of those declines were justified, many were not.

The large tech titans Microsoft, Amazon, Alphabet and Meta were crushed under the weight of selling. Twelve months later investors changed their shorthand name from FAANG to the Magnificent Seven and it was off to the races again. While generative AI was the focus of investors during 2023, it is worth remembering that Microsoft made its initial investment in OpenAI (the creator of ChatGPT) in 2019. There is an opportunity in dislocation.

Maintaining an investment process that favours the long term serves to protect against periods of extreme volatility. It is alarming to hear Buffett talk about investment markets now exhibiting far more “casino-like behaviour” than when he was young. The rise of “meme” stocks and algorithmic funds, coupled with short-term expectations, have created an unstable environment that suits investors with a long-term orientation.

The real risk is permanent loss of capital

The real risk with investing is a permanent loss of capital and not share price volatility. Buffett’s investment process has always maintained this tenet, one that is ignored by most practitioners of modern portfolio theory. Modern portfolio theory ties the risk of a company to its share price movement. This theory asserts a business that has halved in price carries greater risk than it did immediately before the decline. However, value investors would argue that acquiring a company for half its former price is materially less risky than it was at a higher price.

To insure against the risk of permanent capital loss, Buffett always invests with a margin of safety. The margin of safety is a buffer between your valuation and the stock price, ensuring that in instances where the share price moves adversely, the investor doesn’t jeopardise their investment capital. 

It was a philosophy Buffett learned from his professor at Columbia University, Ben Graham, the founding father of value investing. This principle emphasises the importance of investing with a significant buffer to protect against errors in judgment, bad luck, or market volatility.

Vale Charlie