Those of us who prefer to manage our own money are familiar with Warren Buffett. You can't go through an investment journey without reading or hearing one of Buffett’s pithy quotes.

What some may not know is Buffett used two distinct investment strategies over his lifetime. He used the first one described below to become a millionaire but the second to become a billionaire. 

The first strategy he learned was from his mentor Ben Graham, who bought what are called net-nets. These are companies that have fallen out of favour for whatever reason, built still had what Buffett said was one last puff left in them. Cigar butts Buffett called them. If the company’s assets were worth $5 million (its book value) and it’s market cap was $3 million (the value of all its shares) then it was profitable to buy all the shares and liquidate the company making $2 million. At worse, the market would come to realise the value and the stock price would rise to at least match its book value. Buying the stock worth $1 for 60 cents. 

This is how Buffett first got rich. The idea was to buy as many net-nets as possible and wait till the stock price rose back to book value and sell. Either way, the focus was short term with the process repeating by continuously buying and selling the next lot of net nets and spreading your capital across say 50 stocks never risking a large amount on one single stock. Compounding was a result of rolling over short term capital gains that were increasing your starting capital. 

Then he met Charlie Munger who argued it was better to buy good companies and hold them for the long term. They called this strategy - Growth at a Reasonable Price or GARP. This was where Buffett shifted to buying companies like American Express or Coke and waiting for “a very long hill”. Instead of turning over the stocks on a regular basis, Buffett collected the dividend and reinvested them back into the company. 

Buffett hailed this approach as a more successful way to compound capital over the long term.

What can we learn?

In my opinion, if you have a small amount of capital and or are just starting out, then strategy number one - cigar butts - can be a good way to increase your capital in a relatively short amount of time. It requires a decent amount of time hunting and turning over a lot of rocks before finding the undervalued companies but compounding at a higher rate over a shorter timeframe is how Buffett achieved wealth in the first place.

The second strategy - GARP - is better for those who have a goodly amount of capital and are comfortable with a type of buy and hold strategy. Think old people with their superannuation. 

One of the reasons is deciding which is better given the amount of capital you have. Making 50% on $10,000 is good, but making 10% of $1 million is better. But of course, the difference is in the amount, hence why many people leverage into property or stocks.

One aspect you need to consider is how you want to compound your capital. It is ok to find a very long hill, but it does take a while, and you need to be comfortable compounding at a lower rate but realising it is about the amount of money you make (and spend) over your investment journey.

Investors should not be beholden to one strategy as both can be successful in compounding our capital. It is more important to understand what type of investor you are or how much capital you have to play with.