I always think that Warren Buffett is an investor. To me investor means investing for capital gains – buy an asset at a lower price and sell at a higher price in the future. You may say Buffett adopts a buy-and-hold strategy and does not sell shares frequently. Then how does he make such a fortune? If he does not sell, how is he going to profit? I start to get some insights after I read “The Essays of Warren Buffett“, and realised I misunderstood Buffett totally.
Firstly, Buffett buys business. He prefers to buy the entire company from a private owner. This means that the company is not listed and no shares are traded. The business of course must generate a healthy and steady profits. After acquiring this superb cash generating business, he holds on to it. Hence, he invests for cashflow! Find the golden goose and do not settle for lesser. Find enough golden geese and you will be rich!
So, I will not really term Buffett as an investor. He is actually a businessman to me. If you accept this definition, take a look at the Forbes 500 billionaire list. The top 10 or even 20 of them are all businessmen and not investors. Of course, I am not asking you to quit your job and start a business, or give up investing. You must be thinking you do not need to be that rich. I agree, but my point is, the rich are rich because they focus on different things apart from the average. We invest for capital gains while they invest for cashflow. Sounds familiar?
Robert Kiyosaki did admit that it is very difficult to invest for cashflow (from “8 New Rules of Money“). I would think so too. In my opinion, middle-class people can invest in capital gains to build wealth for a start. But it is important to always keep in mind that getting the golden geese is key to riches. As golden geese do not appear frequently, one must be active in search of them while investing for capital gains. The skills and approach to seek out such golden geese are different from the way we do with capital gains. It is important to continually hone the skills to find the golden geese.
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Buffett emphasizes management of the business must be good. He must have trust in them before buying the business. This is because the leadership is responsible how the business will turn out in the future. No matter how good the past results are, are history. To ensure the business will continue to flourish, the brains behind the golden goose (management) must be competent. Buffett is smart in this aspect as he keeps the management intact after buying the business. This means that others will run the businesses for him and it becomes a passive income. Only this way, it is scalable to own several businesses.
I learned that wealth is about the amount of value you created for others. In businesses, profits are determined by the amount of value it provided to its customers through its products or services. So what value does Buffett create for the businesses he buys? And why does anyone want to sell a golden goose to Buffett, and continue to work for him in the business? In my opinion, Buffett is a master asset allocator. With an abundance of capital, any business can get funding from Berkshire to strengthen its competitive advantage. Buffett also has an proportionate incentive remuneration for its subsidiary. If you are able to earn more, you share more profits. Hence, it makes sense that a business owner can sell away the business (capital gain) to Buffett, strengthens its competitive advantage in the industry and continue to earn more money from the running the business (cash flow). These are the values that Buffett can give to them. It is again about value creation and a win-win situation.
Another advantage for investing in cash flow is that there is no fear of stock market crashes or economic downturn. To quote him again from “The Essays of Warren Buffett”, “none of these blockbuster events (oil shocks, one-day drop in Dow of 508 points, etc) made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices.”