Big suicidal mistakes in investing occur when decisions are made without a complete understanding of how a business or a particular industrial sector works. In 1989, Berkshire Hathaway invested US$600 million in Gillette, an investment which grew to US$850 million within two years, besides earning a handy US$52.5 million dividend yield. The idea is to go all in and back a few chosen bets, after detailed analysis. It may be their level of product innovation, acquired monopoly in product or service demand, a sector pioneer’s head start, or any other advantage that keeps them sufficiently ahead of all competition. We want to buy them when they’re on the operating table. A capable, trusted, and candid management is bound to make better decisions to widen the growth prospects of a business.
Timeless Wisdom from the Oracle of Omaha
Ergo, it’s not possible to emulate him, as he casts such a huge shadow on the markets today, that his investments sometimes turn out to be self-fulfilling prophecies due to the high volume of funds he pours in. A consistently high ROE for more than 5 years, marks a company to be a safe bet for investing.
To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. With Wrigley chewing gum, it’s the lack of change that appeals to me. It determines the value of each dollar earned in sales per share, for a company. Make investments to create a second source.
Invest in what you understand
The best thing that happens to us is when a great company gets into temporary trouble . . -Warren Buffett
Lastly, the core principle of Buffetology-once you find a good thing after careful analysis, hold on to it, as with time, it only gets better. A prime example is one of his biggest early bets and successes-Coca Cola, a company whose business model and future potential was rightly gauged by him.
Another such example is See’s Candies, a manufacturer of candy and chocolates, whose products have been in high demand, throughout United States. It is known for constant innovation and predictable market earnings. Since the 1980s, it has been a household brand with a proven market share. These include:
Low Price-to-Book Ratio: This ratio (= Stock Price/Total Assets – Intangible Assets – Liabilities) allows you to screen stocks that are trading below their book value, a.k.a. While a legion of analysts have tried to dissect Buffett’s approach to discover the holy grail of investing, very few have been able to replicate his success.
The master investor, who bought his first stock at the age of 11, doesn’t just buy securities now, but prefers buying controlling stakes in companies, assimilating them into the huge sprawling empire that is Berkshire Hathaway.
Go for companies with highly favorable long-term growth prospects
In the 1990s, he avoided the Dotcom bubble, by eschewing Internet-based businesses, whose future prospects, he did not fully comprehend. Speculative day trading not only incurs high transaction costs and taxes, but also doesn’t add up to substantial profit, compared to a well-thought out long-term bet. I don’t think it is going to be hurt by the Internet.
There are many other parameters that are a part of the scanner employed by the master investor. -Warren Buffett
Go after your strengths, and invest in what you understand. Because he bases his decisions on understanding an industry, instead of relying on hearsay, he has been insulated from the speculation-driven insanity that periodically grips the markets. undervalued stocks, which are bound to appreciate to their true value, in the future.
Low Price-Earnings Ratio: This important ratio (= Market value per share/Earnings per share) can only be used to compare companies within the same sector, to separate those with high earnings, trading at relatively low prices. When Procter Gamble bought Gillette, Berkshire Hathaway being the largest shareholder, earned a handsome profit of US$645 million.
Over the years, as his style of investment has evolved, Buffett, along with his closest business partner, Charlie Munger (Berkshire Hathaway’s Vice-chairman) have also focused on looking at the quality and leadership capabilities of the management, provided all other financial parameters check out. A company whose products and services have enjoyed perennial demand and established large-scale market exposure, is bound to do well. Of course, this strategy requires a lot of conviction in your choices, and at times, the willingness to be a contrarian, when conventional market wisdom thinks otherwise.
The Unbeatable Compounding Machine
For more than 49 years, Warren Buffett’s Berkshire Hathaway has grown at a rate of almost 25% every year. To put things into perspective, if a 60 cm rose bush were to grow at this rate, within 37 years, it would grow to be as tall as the Empire State Building!
In totality, these price multiples can together identify undervalued stocks, a rare breed that a value investor like Buffett prefers buying, as they have a high probability of appreciation compared to other stocks.
It takes 20 years to build a reputation and five minutes to ruin it. It is just that he has avoided blunders and learned from his mistakes through clear introspection.
The growth of his company, which has been beating the SP 500, almost continuously for decades, is testimony to the sound investing principles and mental framework that has helped him choose winners more frequently than others.
Focus on parameters identifying undervalued investments
Wide diversification is only required when investors do not understand what they are doing. Buffett has always believed in investing such companies that have a strong protective moat.
Do not save what is left after spending, spend what is left after saving.
How do you beat Bobby Fischer? You play him at any game but chess. Also recommended reading is the compendium of Buffett’s letters to his shareholders, where he has expounded the essence of his technique, in his unique folksy way. That’s the kind of business I like. Again, this indicator shouldn’t be used in isolation, but only as part of a broad analysis of the company’s financial fundamentals.
High Dividend Yield: The yield (= Annual dividends per share/Price per share) can separate out companies that pay out high dividends for every investor dollar put in.
You only have to do a very few things right in your life so long as you don’t do too many things wrong.
You may not immediately make a killing on the stock market with Buffett’s principles, but you will certainly lose less money with his conservative value-investing approach, which is as good as a win, over a long period of time. An essential reading, is ‘The Intelligent Investor’ by Benjamin Graham, as well as ‘Common Stocks and Uncommon Profits’ by Philip Fisher, the two men, who have influenced Buffett’s approach. Such businesses are the sure-things of the stock market, which may not necessarily post spectacular results in any quarter, but will keep the profit meter ticking steadily.
Be patient, hold on, it gets better
A parameter that is closely monitored by the master investor is the return on equity (ROE), quantified as Net Income/Shareholder’s Equity. While this approach has also led to him missing out on a few good opportunities, it has largely saved him from large-scale losses.
The Key Investing Principles of Buffettology
Lastly, some timeless quotes to live by, from the Oracle of Omaha, that should be pinned on every investor’s work desk.
Risk comes from not knowing what you’re doing.
Another parameter that’s part of the Buffett scanner is the profit margin (Net Income/Net Sales x 100). -Warren Buffett
The most successful student of value investing guru-Benjamin Graham, pin-up boy of investment managers, the Oracle of Omaha, the unyielding CEO of Berkshire Hathaway, and the grand old sire of American capitalists, Warren Buffett is one of the few billionaires who made a substantial chunk of his early fortune, through pure investing.
. To qualify for investment, the profit margin needs to be consistently high and growing for the past 5 years.
If you buy things you do not need, soon you will have to sell things you need.
Market leaders are set apart by the strong competitive advantage (economic moat) that they hold, over their competitors. While this may not always lead to winning bets, it will protect you from the pitfalls of speculative (the-quest-of-the-next-big-miracle) investing.
An example from Buffett’s portfolio is Gillette, a market leader in personal care products, primarily including men’s razors. Consequently, their stock value suffers, and Buffett has always capitalized on such opportunities where the company is trading at a 20% to 25% discount price of its true book value. It measures the benefit generated for the invested shareholder money. It quantifies the net income earned by the company, for a small percentage of shareholder’s equity. Buffett believes in focusing on a few good bets for the long term and doesn’t believe in spreading himself too thin or over-diversifying. Buffett has always restricted himself to investing in businesses that he understands. . By focusing on a chosen few stocks that have passed his extremely detailed scanning test, he increases his holding in them over a period of time to bolster his bet. Let rationality reign over passion in matters of money and investing, and you shall build a solid fortune over a lifetime.
Go for companies with candid, trustable, and capable management
Ergo, invest in your circle of competence, it being the set of business sectors whose products and services, as well as market value, are comprehensible to you, through personal experience. He completely ignores the brouhaha and speculative trends of the market and entirely bases decisions on the study of a company’s balance sheet, market impact, and future potential. This also lets him invest in a high volume of shares of a company, in a single go, acquiring a significant, and at times, controlling stake in companies. All companies start small and the few who can identify their long-term value and prospects at that stage, to invest in them, ultimately reap big returns. -Warren Buffett
The value of a stock is dependent on the projection of its future earnings and if they are highly predictable, it makes for a smart bet. I try to stay in games where I have an edge, and I never will in technology investing. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. Invest only in companies that have good long-term growth prospects.
Buy undervalued growth companies
While he started out as a diligent follower of Graham’s value investing approach, aimed at snagging companies trading at prices lower than their true value, over time, Warren Buffett has absorbed and assimilated a range of ideas from other master investors, like Philip Fisher, and developed his own. Build a framework for choosing stocks, that’s customized according to your risk appetite in investing. True investors are in it for the long run. When considering a stock, think of it for what it is-an opportunity to buy a quantum of ownership in a business. Only in this circle, can you have the conviction to make future predictions. Evaluate its future potential and financial fundamentals, as well as market demand for its products and services. -Warren Buffett
Once in a while, opportunities open up, when innovative companies with high growth prospects get into trouble due to temporary setbacks. He has been known to be greedy and opportunistic during such times, when the market has been fearful about a stock and has earned rich dividends from the recovery of the stock price, in the long term.
Opt for companies with a strong economic moat
In the short term, the market is a popularity contest. This parameter should never form the only screening criteria, as not all low P/E ratios indicate undervalued high-performance companies.
Low Price-to-Sales Ratio: This parameter (= Stock price/sales per share) can be indicative of an undervalued stock. Even he made his share of mistakes, had missed opportunities, and lost a lot of money in the markets. In the long term, the market is a weighing machine. The prime imports from his approach have been outlined in the following lines.
Focus on a few good bets
Never depend on a single income. -Warren Buffett
Investors like Buffett amass great fortunes as they stay invested for the long term in high-growth companies and have the dexterity to spot them early. -Warren Buffett
At the other extreme of non-diversification is over-diversification. Think like the owners of a business when buying a stock, and your approach to the whole process is bound to change.
Our approach is very much profiting from lack of change rather than from change. Berkshire Hathaway’s US$57 million investment in the company has earned more than US$1.35 billion, in the ensuing years.
Choose companies with stable, consistent, and predictable earnings
Our favorite holding period is forever. If you think about that, you’ll do things differently.
Pick businesses with high and stable profit margins
Look for high return on equity
To sum up Buffett’s approach in the simplest of words, he goes after undervalued stocks, with strong financial fundamentals and growth prospects, holding them for the long term