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Warren Buffett’s Stock Investing Principles

Warren Buffett’s Stock Investing Principles

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In 1977 Berkshire Hathaway Shareholder Letter, Buffett give us a glimpse into his stock investing principles:

“We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.   We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term.  In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.”

 

Warren Buffett’s 4 Principles

  1. Choose businesses that you understand

“Never invest in a business you cannot understand.” – Warren Buffett

The easiest way to avoid making a mistake is not investing in companies that are overly complicated or in industries you have little or no direct experience in.

Today, there are tens of thousands of publicly-traded firms out there. However, for most of us, the majority of companies are operating businesses that are to difficult for us to comfortably understand.

Peter Lynch once said, “Never invest in an idea you can’t illustrate with a crayon.” So as a rule of thumb, if you can’t describe the business with a Crayola, you probably shouldn’t invest in it.

“An investor should act as though he had a lifetime decision card with just twenty punches on it.” This quote by Warren Buffett perfectly sums up his approach to investing. We should be extremely careful on which stocks we choose to invest in and choose only the ones that we understand.

 

  1. Choose businesses with favourable long-term prospects

“Our favorite holding period is forever.”- Warren Buffett

Warren Buffett embraces a buy-and-hold mentality because he believes it’s difficult to find excellent businesses that have favourable long-term prospects. This explains why Buffett has a concentrated portfolio.

“The stock market is designed to transfer money from the active to the patient.” – Warren Buffett

Buffett also believes that time is the friend of great businesses. Fundamentals could take years before they have an impact on a stock’s price. But in the end, patient investors will be rewarded for the wait.

 

  1. Choose businesses operated by honest and competent people

“Once management shows itself insensitive to the interests of owners, shareholders will suffer a long time from the price/value ratio afforded their stock (relative to other stocks), no matter what assurances management gives that the value-diluting action taken was a one-of-a-kind event.”- Warren Buffett

Warren Buffet is extremely careful when it comes to selecting his partners and managers because he believes their actions could make or break an investment.

For many of us, we lack the resources that Buffett has to evaluate the character and skill of a public company’s management team for investment purposes. However, we can apply this principle when we choose who to listen to when managing our portfolio or investments.

 

  1. Choose good businesses available at a cheap price

“The stock market is filled with individuals who know the price of everything but the value of nothing.” – Warren Buffett

Stock prices are inherently more volatile than underlying fundamentals of a business and there could be periods in the market when stock prices have no correlation to the outlook of a business in the long term. This meant that many businesses could be priced at a bargain – relative to their quality or long-term potential – during a financial crisis when investors are in a hurry to sell off their companies.

Investors like Buffett took advantage of such situation and invested in businesses that were available at an attractive price. He famously bought $1 billion of Coca-Cola stock in 1988 after the 1987 stock market crash in 1987 which created attractive valuations as businesses were sold with zero regard to fundamentals. Today, Buffett’s investment in Coca-Cola has grew more than 16 times when accounting for dividends.

 

 

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