Many would agree that value investing and finding a company’s [^1]intrinsic value has summed up his investing style well. But what exactly does that mean? And more importantly, how can you do the same?
A brief interview with Warren Buffett where he talked about his investing style
It is easy to understand Warren Buffett’s style but not easy to achieve.
Here’s what I have digested so far by reading books and watching his interviews.
Buying Only Undervalued Company
The definition of undervalue may sound subjective and unclear to you, but there’s a general guideline to it.
You need to find a company using metrics like P/E ratio, P/S ratio, Quick ratio, and Debt To Asset Ratio, etc.
It is OK if you do not understand these terms for now, basically what it means is to look for a company that is:
Currently trading at a lower “value”
To have [^2] margin of safety and to decide if a stock is “cheap”, is based on the metrics above. Not the price number itself. So, when a stock was at 100, is now 80. It doesn’t mean its worth buying or “cheap”. If we don’t know how the company is actually doing.
Has long-term history
It has been proven to make money and will continue to make money in the long-term future. Some companies are just one-time bloomers, especially those start-ups with the “next big thing” idea. It won’t help you build wealth in the long run.
Cheaper than peers
The current value is cheap compared to its competitors using the metrics above. For a fictional example: Car maker Honda with low P/E, P/S and no debt is better than General Motor with a higher P/E, P/S and a bunch of debts. So always evaluate the company’s value according to their industry.
Management is good
A positive working environment and good leadership is the key to a successful business. If the employees don’t like their job, the business will be in trouble soon.
It has its edge and is irreplaceable
Mcdonald is one of Buffett’s favorites. Or an energy company like Chevron, because you’ll always need energy.
Low debt
Well, if a company or a person is doing well, they won’t need to borrow too much money, that’s simple.
What Qualities Do You Need To Have
See, the guide looks simple. What causes losses in investing, however, is usually yourself.
Here are some things you should know:
Don’t try to beat the market
A lot of fund managers tried to trade this and that at certain times, but in the long run, they usually underperformed to S&P500 index. In other words, you can just buy the index and defeat them.
Patience
It is a human natural reaction to panic sell when you see your holdings go way too high or especially sunk a lot. However, Buffett’s idea is always about the long game. If you don’t plan on holding it for more than 5 years, then don’t even buy it in the first place.
Read earnings reports regularly
Numbers don’t lie. No matter how excellent a speech the CEO has given. If the numbers don’t tell the same, it means a no go. Keep an eye on the company changes in facts, always.
Put all eggs in one basket
Yup, you read that right. He said that it is easier to manage a few companies over a lot of companies. So diversification is not the key, which is against what a lot of financial advisors suggest. In his view, eggs can be maintained better if they are selected well and closely monitored.
What If You Don’t Want To Spend The Time To Study Companies
Invest in the index
SPY and VOO are ETF tickers that track the largest 500 companies in the US. It is passively selected, so buying 1 share of SPY means you own a fraction of all the best 500 companies in the US. VTI is another one for the global market.
Invest regularly
Warren Buffett said that he made some mistakes by doubting the US market, and he shouldn’t have. By religiously investing monthly into the index, history shows wealth can be built over the power of compounding.
What Now
Now that you have a general idea of how Warren Buffett picked his stocks. It is OK to not follow his style. It’s just that his method seems to be working so far, for him at least.
However, it also matters if you are suitable for the same type of investing style. Because you know, people are diverse.
Good Luck.
The book "The Intelligent Investor" written by Benjamin Graham is well praised by Buffett and it has had made major influence on his investing style.
[^1]: Intrinsic Value means the underlying value of the company – the real value, not the stock price. Read more on Investopedia
[^2]: Margin Of Safety is the distance between the underlying (potential) value of a company compared to the current value.
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