Invest Like Buffet
Warren Buffett is among the wealthiest people in the world, and many consider him the world's most excellent stock picker. You can learn from Warren Buffett and increase your wealth.
Though Mr. Buffet has never officially written down his process for evaluating and choosing stocks, there is a lot that investors will learn from his letters to his shareholders.
These rules are in line with those shareholder letters:
Rule #1: Don't Lose Money.
Warren's basic philosophy is to purchase a stock for less than it's worth and then let the rest of the world figure it out. Buying companies in this manner is what he calls "Value Investing" and has been the lynchpin of his philosophy from the very start.
Usually, you'd hear about Buffet's Rule #2, which is "Don't Forget Rule #1."
Still, in this article, you'll find various ways to quickly identify companies that align with Buffet's value investing philosophy in the following rules.
Rule #2: Strong Profitability.
Buffet prefers already profitable companies over companies that might become profitable someday. In addition, the company should have strong profitability measures, such as Return on Equity (ROE), Return on Invested Capital (ROIC), and profit margin
Buffet prefers already profitable companies over companies that might become profitable someday. In addition, the company should have strong profitability measures, such as Return on Equity (ROE), Return on Invested Capital (ROIC), and profit margin
- ROE – While no one knows for sure, the consensus is that he wants to see an ROE of 15% or more.
- Profit Margins – In this case, we're talking about dividing net income by net sales. The higher, the better.
Rule #3: Low Debt.
Too much debt load is a strong negative for everybody, including companies. So if you thought we skipped ROIC above, we're returning to it now. Sometimes a company will appear to have a high ROE, but the number is artificially inflated. This can happen when the company is using debt to pay its bills. This is where ROIC comes into play.
Too much debt load is a strong negative for everybody, including companies. So if you thought we skipped ROIC above, we're returning to it now. Sometimes a company will appear to have a high ROE, but the number is artificially inflated. This can happen when the company is using debt to pay its bills. This is where ROIC comes into play.
The ROIC metric removes debt from the calculation by adding it back to the shareholder equity before using the ROE calculation. Divide the company's total liabilities by shareholder equity before calculating ROE. A high ratio indicates that the company is using debt to finance growth.
However, be careful when interpreting the ROIC ratio, as a high number can sometimes indicate financial distress. Also, high-interest rates or a credit crunch can make a company vulnerable to credit and lending risk.
Rule #4: Competent Management.
Buffett has always placed much emphasis on a company's management team. He favors intelligent, humble management that doesn't simply follow the crowd. He has stated that his company allocates capital; it does not provide day-to-day management.
Buffett has always placed much emphasis on a company's management team. He favors intelligent, humble management that doesn't simply follow the crowd. He has stated that his company allocates capital; it does not provide day-to-day management.
Historically Buffet has stayed out of influencing a company's management; however, he insists that good management be present. So make sure a competent management team runs the companies in which you invest.
Rule #5: Comprehension.
Buffet famously has said he won't invest in a business he doesn't understand. You will find that the businesses in which he invests are relatively simple. It's also widely known that he largely avoids technology companies because he doesn't feel he understands that industry well enough. He believes it's essential only to invest in what you are capable of understanding.
Rule #6: Patience.
Buffett is known for holding onto stocks for years before selling them. He has stated that value investing takes time; you must be patient to see the returns. Don't be in a rush.
Buffett is known for holding onto stocks for years before selling them. He has stated that value investing takes time; you must be patient to see the returns. Don't be in a rush.
While it is true that we cannot all be Warren Buffett, we can improve our investing results by following his fundamental principles. Specifically, we should focus on underpriced companies with a history of profitability, little debt, and a competent management team. Additionally, it is essential to be patient to see returns.
By adhering to these guidelines, we can surprise ourselves with the amount of wealth we can accumulate over time.