Investing from a Business Perspective
The fundamental tenet of Warren Buffett's investing philosophy, that allows anyone to take advantage of other people's fear and greed.
Without Graham’s principle of “investing from a business perspective,” Warren Buffett would never have become one of the greatest investors of all time, as this idea forms the core of his investment philosophy. It is the foundation for applying first-principles thinking to investing. The practice is uncommon, unpopular, and uncomfortable. It requires long-term commitment and dedication despite constant opposition from Wall Street and Main Street to reap its rewards. However, when fully embraced, it gives investors the ability to achieve the highest possible returns on their investments.
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“Investment is most intelligent when it is most businesslike.” – The Intelligent Investor by Benjamin Graham
Warren Buffett emphasized the importance of viewing investing from a business perspective in his 2013 letter to Berkshire Hathaway shareholders, citing his mentor, Benjamin Graham1.
Without Graham’s tenet of “investing from a business perspective,” Warren would have never become one of the greatest investors of all time, as this concept is the bedrock of his investment philosophy.
Warren learned the concept of investing from a business perspective from one of his many teachers and mentors, Benjamin Graham, when he was Graham’s student at Columbia University, and later observed Graham apply it at his investment firm, Graham-Newman Corporation.
Investing from a business perspective is a component of applying first-principles thinking to investing. The practice is uncommon, unpopular, and uncomfortable. It requires long-term commitment and dedication to reap its benefits, in the face of constant attack by Wall Street and Main Street.
However, when you understand what it means to invest from a business perspective and appreciate its benefits, you will no longer allow your emotions or the market to dictate your capital allocation; instead, you will learn to profit from other investors’ follies driven by fear and greed. You will start to notice great investment ideas that others miss. It will completely change how you think about businesses and investments.
Applying first-principles thinking to investing
When Benjamin Graham and Warren Buffett evangelize investing from a business perspective, they are actually talking about investing from first principles. A first principle is a basic proposition that cannot be deduced from any other proposition or assumption. First-principles thinking, therefore, is a process of breaking problems down into their basic components and reasoning from there.
The first principles of investing are the most basic, enduring truths that underlie any sound investment decision: a stock is ownership in a real business, that business is ultimately worth the cash it can generate for its owners over time, which depends on the economics of the business, and your results depend on the relationship between the price you pay and that underlying business value. Reasoning from first principles means returning to these facts whenever you make an investment decision, rather than being led by headlines, price movements, or market sentiment.
A first principle is a basic proposition that cannot be deduced from any other proposition or assumption. First-principles thinking is a process of breaking problems down into their basic components and reasoning from there.
Warren Buffett, Peter Lynch, Mohnish Pabrai, and other successful investors break down businesses into their basic components, digging deeper than your average retail investor to understand their economics and the levers that will drive their growth over the long term.
By taking apart potential investments, understanding how each component performs, and selecting only the businesses with the strongest business economics and the most durable long-term competitive advantage, you will discover a handful of great businesses that will deliver exceptional results.
Benefits of investing from a business perspective
If you have never thought about investing from a business perspective, it will open your eyes to the businesses behind stocks and their economics. When you commit to investing from a business perspective, you will:
think as a business owner, as if you were running the company.
no longer be tempted to buy stocks because Twitter Finance or FinTok says a stock is going to the moon, or “play” earnings.
stop looking for opportunities that offer a 25% or even 50% return over the next few months, and instead look for businesses that will continue to grow over 5 to 10 years or even longer and produce an annual compounded return of 15% or better.
realise that people diversify to protect themselves from their own mistakes, and that investment professionals praise diversification to collect more fees.
start noticing great investment ideas every time you shop.
realise that a $1,000 stock could be cheap compared to a $10 stock.
start thinking of stocks as bonds with variable rates.
wait and wish for the market and stock prices to fall so that you can buy partial ownership of publicly traded businesses you have been wanting to own.
Take advantage of others’ fear and greed.
The major benefit of investing from a business perspective is the ability to take advantage of minute-by-minute business valuations that publicly traded securities provide.
Investors in stocks have an enormous advantage: they receive offers for their businesses as long as stock exchanges are open. In the future, as more and more securities become tokenized, investors will be able to access minute-by-minute valuations around the clock.
Not only do you have the ability to receive thousands of offers for your businesses and every single publicly traded business on the planet on a minute-by-minute basis, but many of those offers are wildly mispriced. An investor who thinks from first principles can and should take advantage of such mispriced offers.
It is no different if you own a neighborhood grocery store, and nearby store owners come by your store daily and offer to purchase your store or sell theirs. On days when your neighbors feel jolly and offer to buy your store at ridiculously high prices, you may decide to take them up on their offer and sell the store, or choose to ignore them. However, when they offer to sell you their store at similarly observant prices, you have no obligation to purchase it from them.
Warren, like any investor who thinks from frist principles and has a long-term view, can only benefit from the swinging moods of other market participants.
On the other hand, when your neighbors feel depressed and offer you below-market value for your business, you have no obligation to sell, no matter how depressed the economy and business buyers are. However, if they offer to sell their business at a depressed price, you may take them up on it.
Warren and other successful investors take advantage of other market participants whose emotions about the market, the stock, or something in their personal life drive them to offer prices that are too low or too high. If you think long-term and view stocks for what they are - ownership of operating businesses, you cannot lose money investing in stocks because of variables you cannot control, such as the behavior of other market participants.
Betting on the actions of other market participants is how speculators try to benefit. It is the only thing a speculator bets on: someone else taking action that would benefit them, such as paying more than they did. Expecting someone else to take action that benefits you is a time bomb waiting to explode your portfolio.
Wall Street and Main Street don’t want you to invest from a business perspective.
Although Warren constantly talks about it during shareholder meetings and college lectures, most investors, whether professional investors on Wall Street, Frankfurt, or Tokyo, or retail investors on Robinhood, still ignore it.
The reason this simple concept has eluded so many is that Warren’s approach runs counter to the business model of the investment profession as a whole. If investors had only looked at investments through the business lens, a large swath of the investment management profession would not exist.
Investing from a business perspective is not a formula that can be relied on to produce a profit in every situation. It is, rather, as Graham put it, “a negative art.” It is a discipline that helps investors avoid pitfalls and identify what not to invest in, as much as what to invest in. This is precisely why the financial industry is not promoting it.
Stock price movements, company news, and economic reports provide many reasons to trade a security, which is how a large portion of the investment community makes money, either by providing services and products to trade securities or by providing information to trade on.
Investing from the business perspective is a “negative art” that mostly helps avoid bad investments.
Robinhood’s entire business model, like those of all brokerage firms, gambling houses, sports betting operations, and prediction markets, is based on trading volume, which is the opposite of investing from a business perspective. The more transactions those businesses can push through their platforms, the more profitable they are.
All of the above businesses benefit from high trading volume, so it is not in their interest to help investors avoid bad investments—quite the opposite. Regardless of an investment’s outcome, they earn a fee every time investors buy or sell a security, either upfront or on the back end, such as the payments for order flow that “commission-free” brokerages like Robinhood use.
Much of the financial industry promotes ideas that run counter to investing from a business perspective because the more you focus on buying and selling stocks, the less you view investing as committing capital to real businesses. This creates a greater distance in your mind between a company’s business operations and the stock. Which in turn creates space for someone to come in and dictate what you should think and, in turn, do about a stock.
This is precisely why Warren and Graham always said that:
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.” - Benjamin Graham
In the short term, anyone can convince you of what to think and do about any particular stock, but in the long term, the business’s fundamentals will dictate how the stock is priced. This is why it is crucial that investors look at the fundamentals of the businesses they intend to invest in; in other words, look at investments from a business perspective, rather than as speculators guessing where the price will be over a period of time.
Choosing to invest from a business perspective creates a moat in your mind that protects you from your own emotions, daily news, the whims of the market, and the persuasion of the trading platforms and investment analysts. It allows you to focus on the first principles of investing—the business itself.
Investing from a business perspective is uncommon, unpopular, and uncomfortable. If you want to see businesses the way successful investors do and improve your chances of finding and investing in great businesses with strong business economics at low prices, you must commit to seeing investments from a business perspective and have the discipline to stick to it despite constant pressure to trade.
Discipline is paramount
The characteristics of the businesses Warren invests in will vary based on the nature of the investment. The company he invests in for arbitrage purposes will not have the same qualities as the one he invests in for the long term. Regardless of the type of business or the nature of the investment, Warren always uses a business perspective as the foundation for his decisions.
Having a business perspective on investing is more than a philosophy—it’s a discipline that requires absolute devotion. Without discipline, you will succumb to the whims of the markets and your emotions, buying stocks when everyone is excited about them and selling when the market is full of fear. Having the discipline to commit capital to investments only when it makes sense from a business perspective will allow you to use the market’s whims and other investors’ emotions of fear and greed to your advantage and profit from other people’s lack of discipline.
The formula of investing from a business perspective
The nature of the business enterprise and whether it can be bought at a price that will yield a sufficient return will determine the investment’s worth and whether or not we are investing from a business perspective. - Buffettology by Mary Buffett & David Clark
What does it mean to invest from a business perspective? It means one stops thinking of the stock market or other financial markets as something to buy and sell on its own and starts thinking about the economics of businesses that those securities represent.
A common stock is a partial ownership interest in a business organization, a legal entity that offers products and services to its customers, employs people, pays taxes, and tries to outperform the competition.
It was Graham who taught Warren to ask (a) what business? and (b) on what terms is the investment being made? instead of asking (a) which stock? and (b) how much is it? This frames the questions in a more businesslike manner.
Warren’s main innovation was to buy excellent businesses at prices that made business sense. In Warren’s world, business sense means the business he invests in provides the highest possible, predictable annual compounding rate of return with the least amount of risk. The reason Warren is able to do this better than others is that he thinks long-term, like a business owner, unlike Wall Street and retail investors who focus on the next few quarters.2
Thinking like a business owner
Warren can ignore stock price fluctuations and focus on business economics because he understands that stocks have no value on their own and are nothing more than equity-based financial instruments representing legal ownership of a business3. So before Warren makes an investment, he assesses the business’s economics, which helps more accurately value the business, and only then decides which financial instrument of the company will yield the highest return.
Graham taught Warren to ask (a) what business? and (b) on what terms is the investment being made? instead of asking (a) which stock? and (b) how much is it? This frames the questions in a more businesslike manner.
Similarly, he doesn’t limit himself to short-term gains. There are many advantages to investing for the long term, including allowing compounding to work in his favor, reducing the number of times he pays taxes, decreasing the number of new investments needed, and others that we will cover in future discussions.
Warren discovered that the best returns come from investments that compound at high rates over the long term. The best investment, therefore, is a business that can reinvest capital at high rates of return over the longest amount of time.
Focusing on the long term will help you focus on the business economics of your investment opportunities, which in turn will help you find excellent businesses, giving you the patience to wait for them to go on sale before buying.
This realization encouraged Warren to think long-term, which in turn led him to see stocks as ownership in businesses. This perspective helps him separate the unpredictable fluctuations of stock prices from the underlying economics of those businesses and to patiently wait for stock prices, in other words, company valuations, to decrease, allowing him to invest in those companies at a low market value relative to their long-term potential, which he can evaluate based on the business economics.
The best investment, therefore, is a business that can reinvest capital at high rates of return over the longest amount of time.
One way to help you think like a business owner is to focus on how much you would have to pay to buy the entire company and whether you would buy it at that price, rather than on the stock’s price. If you believe the business will grow over the long term, it’s simply a matter of waiting until the stock drops enough to produce the rate of return you desire. Warren always looks for an annual compounded rate of at least 15% to ensure it exceeds inflation and provides enough profit after paying capital gains taxes, so 15% is a good starting point.
Comparing investment returns
Warren wants to buy excellent businesses at prices that make business sense. In Warren’s world, an investment makes business sense if it provides the highest predictable annual compounding rate of return possible with the least amount of risk.
Continuing with our example above: if I offered to sell you a neighborhood grocery store, you would review the accounting books to see how much money the business is making. If it is profitable, you would look at whether the profits are consistent, in other words, predictable, or vary year to year. If the store is consistently profitable, you would then ask whether that could change in the future. If the answer is no, given that it’s the only store in the area, you would ask what the store is selling for.
In Warren’s world, an investment makes business sense if it provides the highest predictable annual compounding rate of return possible with the least amount of risk.
Once you know the asking price, you compare it to the store’s annual earnings to determine the return on your investment. A $100,000 asking price against $25,000 in earnings would yield a 25% annual return ($25,000 / $100,000 = 25%).
Once you know the estimated return, you can compare it with other potential investments to determine if 25% return is a good investment. In other words, you would be comparing rates of return. If something looks attractive, you make the investment.
This is how Warren thinks. Whether he is buying an entire conglomerate or a partial interest in a neighborhood grocery store, he asks himself: How much money can this business predictably earn, and what is the asking price? When he knows the answer to those questions, he can compare it to other opportunities.
Warren prioritizes ownership of the powers of production in great businesses over the short-term profits promoted by Wall Street.
Owning a business that yields 25% annually for 20 years is a great investment. Would you consider selling it during a tough year if someone offered to buy it at a depressed price? Or would you sell it for 30% or even 50% more than what you paid for it during a year of market exuberance? A Wall Street manager would undoubtedly do so to show prospective investors a great annual return. But that would invite the IRS, cut the overall return, and leave you with the rest of the capital and potentially worse investment opportunities.
Warren, like a good businessman, prefers to hold on to investments that can predictably produce an annual return of even 15% over the long term. This keeps the IRS at bay, compounding working in his favor, and leaving less capital to worry about. Like Warren, you should prioritize ownership of the powers of production in great businesses over the short-term profits promoted by Wall Street.
Warren’s two small investments from a business perspective
In his 2013 letter to Berkshire shareholders, Warren gives two examples of investing from a business perspective.
Nebraska farm
From the mid-1970s to the 1980s, agricultural commodity prices rose sharply, with wheat prices doubling and corn prices tripling, as the U.S. government reduced its reserves from the large surpluses of the 1950s and 1960s, eventually falling to 8% of annual national production. Additionally, in 1972, the U.S. signed a multi-year trade agreement on wheat and feed grains with the Soviet Union, further increasing demand for American agricultural products.
Lowered grain reserves and increasing demand from international markets, such as the Soviet Union, pushed prices higher and made farming highly profitable. This led farmers to borrow more to expand their operations, local and regional banks to ease lending practices, and the value of farmland to rise, creating upward pressure for farmers to borrow more.
It all came crashing down when the Soviet Union invaded Afghanistan in 1979, and then President Jimmy Carter imposed a grain embargo, halting shipments of grain to the Soviet Union. Additionally, the Federal Reserve raised interest rates, reaching a record 21.5% in 1981 to combat inflation. The combination of these two factors reduced demand for agricultural products and made borrowing more difficult.
By January 1984, the Federal Reserve Board released a report estimating that one-third of all American farmers held nearly two-thirds of the nation’s total farm debt. As commodity prices eventually declined, leveraged farmers found themselves with enormous debts, leading to widespread farm foreclosures and five times higher failure rates among Iowa and Nebraska banks compared to the Great Recession.4
This is where Warren steps in. Seeing prices drop by 50%, Warren buys a 400-acre farm 50 miles north of Omaha. Without any farming experience, Warren learns from his son about the farm’s potential yields and operating costs. Using that information, Warren estimates the farm will generate around 10% normalized returns. He also believes productivity will improve over time thanks to advances in agricultural technology, and that crop prices will eventually recover from their record lows, which both turned out to be true.
Warren didn’t need any special knowledge or intelligence to evaluate the farm or estimate its profitability from growing crops, concluding that the investment involved little risk and had significant upside. Most importantly, he didn’t rush to buy the farm when the market was booming, and everyone was competing for farmland, driving prices higher. Instead, he waited for the right moment when economic conditions aligned, making the investment a no-brainer.
Warren did not let the market dictate the price or the timing of his investment. Instead, he waited until the upside was exponentially higher than the downside.
Warren understood that crops would have both good and bad years, but over the long run, the farm would perform well. The low price he paid makes it a profitable investment that beats inflation and covers taxes. Importantly, he will never be pressured to sell it, which allows for long-term, multi-decade growth.
By 2013, Warren still owned the farm 28 years after acquiring it, as mentioned in the Letter to Berkshire Shareholders. The farm had tripled its earnings and was now worth five times his original purchase price. Despite this, Warren had little knowledge of farming, having visited the farm only twice.
Manhattan real estate
Another opportunity presented itself after yet another boom-and-bust cycle, this time in New York commercial real estate. During the 1980s, the U.S. government deregulated savings and loan associations (S&Ls), allowing them to finance risky, speculative commercial and residential projects. This resulted in significant speculative development in Manhattan and led to an oversupply of office space. Heavy foreign investment, particularly from Japanese investors, further drove up property prices. Moreover, lenders used high loan-to-value ratios, assuming property values would keep rising forever.5
Naturally, nothing lasts forever, and the exuberance of lending and development was tested when the large-scale, speculative building boom of the 1980s confronted a market with high vacancy rates, causing rental incomes to decline, about one-third of all S&Ls, or roughly 1,600 institutions, to fail, and real estate prices to drop. The failure of S&L institutions triggered a sudden liquidity crisis, preventing developers from refinancing and forcing them to sell assets at severely reduced prices. From its peak in 1987 to its low in 1997, real house prices in New York City fell approximately 31%6.
Again, investors like Warren Buffett and Peter Lynch, who think from a business perspective rather than a speculative one, were presented with an incredible opportunity to invest in real estate and in struggling savings and loan associations for pennies on the dollar.
In his 2013 letter, Warren explains that analyzing the New York retail property next to NYU was as straightforward as analyzing a farm. He concluded that the property’s unleveraged current yield was about 10%.
Unleveraged current yield measures an asset’s annual return from operations before debt financing, taxes, or leverage. It shows the cash-on-cash return for all-cash buyers, reflecting pure operational efficiency and isolating the property’s income capacity.
Calculated as Annual Net Operating Income / Total Acquisition Cost.
The property was poorly managed by the previous owners, and its income is expected to increase once several vacant stores are leased. Additionally, the largest tenant, occupying about 20% of the space, was paying approximately $5 per square foot, while the other tenants paid around $70 per square foot. The expiration of the undervalued lease in nine years will significantly boost earnings. As with any real estate deal, location is crucial. This retail building is located directly next to NYU, a stable institution likely to attract steady future traffic, ensuring good business for the tenants.
As old leases expired, earnings tripled. Annual distributions in 2013 surpassed 35% of Warren’s original equity investment. Additionally, the initial mortgage was refinanced in 1996 and again in 1999, moves that resulted in several special distributions totaling more than 150% of what Warren had invested. Warren had not yet viewed the property as of the time he wrote the letter in 2013, since he had purchased it in 1993.
Lessons from Warren’s two small investments
You don’t have to be an expert to get good investment results (and we will show you how).
You must recognize your limitations and follow a reasonable course of action, such as making investments during times of financial downturns and fear, not when prices are inflated by exuberance during market bubbles.
Keep things simple and don’t swing for the fences.
When someone promises quick profits, respond with a quick ‘no.’
Focus on the future productivity of the assets you’re considering; in other words, invest from a business perspective.
If you’re not comfortable making a rough estimate of the asset’s future earnings, skip it and move on.
No one can accurately evaluate every investment opportunity. And you don’t need to. You just need to understand the actions you take.
If you concentrate on the potential price change of an investment, you are speculating. There is no way to accurately predict something’s price. Many variables at any given moment can influence the price over a short period. Therefore, speculation is a fool’s errand. As Warren said in his 2013 letter:
”Half of all coin-flippers will be correct in their prediction, but none of them can expect to continue guessing correctly.” - Warren Buffett, 2013 Letter to BRK Shareholders
The fact that an asset has appreciated recently has no effect on its future appreciation and should never be the reason to purchase it.
With his two investments, Warren focused solely on what the properties could generate in the future and paid no attention to their daily valuations.
“Games are won by players who focus on the playing field - not by those whose eyes are glued to the scoreboard.” - Warren Buffett, 2013 Letter to BRK Shareholders
Forming macro opinions, like trying to predict the government’s policies, international trade agreements, or interest rates, or listening to macro and market predictions, is a waste of time. On the contrary, paying attention to commentators and pundits can obscure your view of the most important facts, such as the investment’s business economics.
“When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: ‘You don’t know how easy this game is until you get into that broadcasting booth’.” - Warren Buffett, 2013 Letter to BRK Shareholders
When Buffett made those two investments in 1986 and 1993, he didn’t care about what market commentators were saying, interest rates, or how the economy would perform in the future. No matter what the pundits predicted at the time, the corn would keep growing in Nebraska and be consumed around the world, and students would continue to attend NYU.
Although the two small investments Warren made performed well shortly after he made them due to their incredibly low prices, they didn’t have to perform well immediately to make financial sense. They will continue to generate cash for Warren, and most importantly, for his children and the children of their children. That is the beauty of investing from a business perspective.
“The two investments will be solid and satisfactory holdings for my lifetime and, subsequently, for my children and grandchildren.” - Warren Buffett, 2013 Letter to BRK Shareholders
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