Many factors have contributed to making Warren Buffett one of the world’s most successful investors ever. However, I think his biggest secret — and one from which we can all benefit as investors — is a fundamental one. Honesty.
Buffett possesses it in abundance. Indeed, he’s renowned for it. As his official biographer Alice Schroeder wrote of one instance: “A small forest of trees was felled in media coverage of Buffett’s honesty.”
Here, I’m going to focus on how I think honesty is an essential part of his highly successful investing process.
Weighing opportunities
Many people find an interesting stock idea, study the valuation, look at the outlook for earnings and dividends, and so on. Finally, they might get round to asking “what could go wrong?” although when I read stock discussion forums, I see plenty of investors who haven’t considered the question and are resistant to doing so.
In contrast, Buffett’s honesty means he always considers what could go wrong. Indeed, as his biographer has told us, “the first step in Warren’s investing process is always to say: what is the odds that this business could be subject to any kind of catastrophe risk that could make it just fail?”
Honestly weighing an investment opportunity demands we look as much at the negative potential as the positive. This is why, at the foot of this article, you’ll find a paragraph that concludes: “Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.”
The ‘too hard’ pile
I think a big reason why some investors are resistant to considering a full range of insights is a fear of finding the business and/or its valuation too complicated. However, you’d be in good company.
Buffett has three categories when evaluating a stock: yes/no/too hard. His partner Charlie Munger has said: “We throw almost all decisions into the too hard pile, and we just sift for a few decisions that we can make that are easy.”
There’s nothing wrong with having the honesty to say “too hard” — or, in Buffett’s phrase, “outside my circle of competence.” In fact, being able to admit you don’t understand a business or its valuation is a big positive.
Mistakes
Buffett only invests in stocks he understands, because “I want to be able to explain my mistakes.” He believes if he’s honest with himself and others about his mistakes, he’s more likely to learn from them. He’s often brutally honest. His mea culpas to his shareholders are typically a full and frank explanation of how and why he got something wrong.
Everyone gets things wrong — it’s part of the process and practice of investing — but the investor who ignores his or her mistakes, or is always trying to blame someone or something else for them, is doomed to go on repeating them, never to become a better investor.
Honesty is the best policy
In summary, I think Buffett’s honesty enables him to make a true assessment of an investment opportunity (pros and cons), to admit when he finds a stock too hard to understand, and to acknowledge and learn from any mistakes he makes. I reckon these have been key elements in Buffett’s success, and that for him — and us — “honesty is the best policy.”