The New Buffettology

Before we bust out of the gate you need to know something important about Warren Buffett. He doesn't "play" the stock market -- at least not in the conventional sense of the word. He is not interested in current investment trends, and he avoids the popular investments of the day. He doesn't chart stock prices, nor does he partake of the current Wall Street rage known as momentum investing, which dictates that a stock is attractive if its price is rising fast, and unattractive if it is quickly falling. This is the most unusual aspect of his investment philosophy, for throughout his investing life he has made it a point to sidestep every investment mania to sweep the financial world. He happily admits to missing the Internet revolution and the biotech bonanza, and he will tell you with a sly smile and a wily chuckle that he has probably missed all of the big Wall Street plays. Then again, he has managed to turn an initial investment of $105,000 into a fortune that now exceeds $30 billion, solely by investing in the stock market.

Here is the big secret: Warren Buffett got superrich not by playing the stock market but by playing the people and institutions who play the stock market. Warren is the ultimate exploiter of the foolishness that results from other investors' pessimism and shortsightedness. You see, most people and financial institutions (like mutual funds) play the stock market in search of quick profits. They want the fast buck, the easy dollar, and as a result they have developed investment methods and philosophies that are controlled by shortsightedness. Warren believes that acts of shortsightedness have great potential to unfold into investment foolishness of huge proportions. When this happens, Warren is patiently waiting with Berkshire's billions, ready to buy into select companies that most people and mutual funds are desperately trying to sell. He can buy fearlessly because he knows which of today's corporate pariahs the stock market will covet tomorrow.

Warren is able to do this better than anyone else because he has discovered two things that few investors appreciate. The first is that approximately 95% of the people and investment institutions that make up the stock market are what he calls "short-term motivated." This means that these investors respond to short-term stimuli. On any given day they buy on good news and sell on bad, regardless of a company's long-term economics. It's classic herd mentality driven by the sort of reporting you'll find in the Wall Street Journal on any given morning. As goofy as it sounds, it is the way most people and mutual fund managers invest. The good news -- the news that gets them to buy -- can be a headline announcing a prospective buyout or a quarterly increase in earnings or a quickly rising stock price. (It may seem insane that people and mutual fund managers would be enthusiastic about a company's shares simply because they are rising in price, but remember, "momentum investing" is the current rage. As we have said, Warren is not a momentum investor. He considers the approach sheer insanity.)