Warren Buffett’s investment rules and investment strategy
Hello! Warren Buffett is rightfully considered one of the most famous and successful investors in the history of the stock market. Thanks to his phenomenal ability to predict the growth of stocks, he was even nicknamed "the oracle of Omaha."
At the end of 2020, he ranked 6th on the Forbes list, and his fortune was estimated at almost $88 billion.
The investment strategy of Warren Buffett is recognized by many as a reference, and his words differ in quotes. He really has a lot to learn.
Today I decided to collect Buffett’s investment rules for you, as well as describe his investment strategy and give some of the favorite and famous rules of life of a great investor.
When choosing assets, Buffett focuses solely on fundamental analysis. He does not buy shares, but a share in the business. Therefore, the choice of each company is approached with special attention.
Sustainable growth momentum
Buffett has little interest in stocks that are rising too fast. He believes that the fall could be just as swift.
Since his main "buy and hold" strategy involves holding papers for at least 10 years, he must be confident that the business will continue to grow in the future.
Of course, past growth does not guarantee the same in the future, but long-term growth in profits and sales provides some assurance.
Return on equity
A well-known investor likes to repeat: "Show me profit and real money." He prefers to invest in companies that are able to generate sufficient cash flow to develop and expand their own business.
Businesses that require huge capital investments just to keep the equipment running, Buffett avoids. These include, for example, issuers in the mining industry.
The standard formula for calculating net cash flow is as follows:
Net earnings per share + depreciation per share
Buffett adds capital costs to this formula, which must be subtracted from the cash flow.
He calls this indicator the net profit of the shareholder. All figures necessary for calculations can be obtained from the company’s annual reports.
It is logical that the profit of the company should grow, and high costs ultimately reduce the return on assets. The higher the profitability, the better the business is doing.
Profitability can be calculated using the formula:
Profit after tax / Sales volume
The result should be compared with data for previous years, as well as with industry averages and the results of competitors.
Equity, or as it is also called the net worth of a business, is the amount of money that shareholders will receive in the event of a company liquidation.
This value is calculated as follows:
Total Assets – Company Debt Amount
Equity per share can be found by dividing equity by the number of securities issued.
In the mid-1950s, a well-known investor bought shares at a price close to the amount of equity per share and sold them at the moment when the quotes rose above this mark.
Today, Buffett evaluates the dynamics of equity over several years and looks at whether this indicator is ascending or descending.
Buffett always looks at the company’s return on equity, i.e. the ratio of net income after taxes to equity, and compares it with other issuers in the industry. This indicator shows the return on assets.
The higher the ROE, the more efficiently the depositors’ money works. An indicator of 15% or more is already considered quite good.
Another key indicator is the ratio of the issuer’s debt to its capital. It is considered positive if the company has a small debt, but at the same time, profit growth is not at the expense of borrowed funds, but at the expense of equity.
The D/E multiplier is used to assess the ratio of equity to debt. The higher it is, the greater the share of own funds in the issuer’s capital.
Buffett rarely pays attention to those enterprises whose products are identical to others in this sector. He prefers to invest in companies that have a competitive advantage.
Buffett only invests in companies that have been on the market for at least 10 years or more.
This term was coined by Warren Buffett himself and it was this indicator that, according to the investor, made him a billionaire.
The intrinsic value of a company is its economic potential. To assess it, you need to understand how much it underestimates, or vice versa, overestimates the market of a particular issuer.
Commandments of Warren Buffett
In this section, I have collected more general rules that the famous investor recommends to follow in order for financial investments to be the most effective.
The longer the better
According to Buffett – the most optimal period of ownership of shares – eternity. Investments that can bring real returns require patience.
The eminent investor is convinced: "If you are not ready to hold assets for 10 years, you may not even think about buying them."
Don’t buy assets just because a company has had a good year or is planning to release new relevant products in the near future. This approach is simply not Buffett’s style.
He considers trading activity to be the main enemy of profitability. The more you buy and sell, the more fees eat into your profits.
Invest in what you know
Buffett says, "The biggest mistake is to invest in a business that you can’t understand." The same applies to the industry as a whole.
If you decide to invest in a company just because you’ve heard a lot about it, it’s best to spend some time researching it. Being guided by someone else’s opinion is not the most successful strategy.
Quotes do not always depend on the actual state of the business at the current moment. Price is what you pay and value is what you get.
In moments of crisis, investors massively get rid of securities, while companies at this time can increase their potential and strengthen their business positions.
Daily market fluctuations are not something to worry about
It simply does not make sense for a long-term investor to worry about minor drawdowns in quotes. If you aim to hold papers for decades, then there is no need to follow the news, worry about crises and world instability.
Make a list of criteria for selecting assets
The price of a share is not the only thing to be guided by when choosing assets in your investment portfolio. The company must have long-term positive fundamental characteristics and competent management.
The quality of the company is above all
Buffett said, "It’s better to buy the stock of a great company at a good price than the stock of a good company at a great price."
But in order to assess the quality and prospects of a business, you will have to plunge into fundamental analysis.
In addition, it is worth collecting as much information as possible about the people who run the company.
- Firstly, the decision to sell should be balanced and not depend on emotional swings.
- Secondly, you should not be afraid to get rid of the shares of companies that have ceased to meet your goals and meet the specified criteria.
Holding assets for decades is fine, but you are still the master of your investment.
And in order not to have to urgently get rid of assets bought spontaneously, you should not invest just to invest. If there are no suitable tools yet, it is better to hold your savings in cash for a while and wait.
Investment is not rocket science
Investment does not require a high IQ, but it is an art to learn nonetheless. There is no button here to make you successful. Any positive results require thought and time.
For 60 years, Warren Buffett has proven the effectiveness of the simplest investment strategy – Buy and Hold, which translates as "buy and hold." I have already noted that a great investor is very careful in choosing companies for investment, and therefore, on average, holds securities in his portfolio for 10 years or more.
Buffett looks for large companies that have proven themselves in the market, chooses those that employ the most competent managers, waits for a price that is less than the real value of this business, and holds the acquired securities for many years.
Often he bought shares of certain companies when other investors considered such transactions obviously unprofitable.
Below we will look at two of Buffett’s main strategies.
Buying a share in a company that is experiencing serious financial difficulties can only be done by someone who understands the essence of its business well and is able to deeply appreciate these very difficulties.
For example, in 1990, Buffett bought shares in Wells Fargo, which at that time left much to be desired. A significant part of the bank’s loans was provided for the purchase of real estate, which then greatly sank in price. Many believed that the financial institution could have solvency problems due to the possibility of massive loan defaults. The bank’s shares sank 30 points, investors massively got rid of the asset, and Buffett decided to invest in it.
He was convinced that the company’s CEO and his team would be able to bring the company out of the crisis.
And so it happened. The bank carried out several transformative reforms, and the real estate market itself soon revived significantly.
So almost $400 million invested by Buffett turned into almost $2.4 billion by the end of 1999.
Investments during the global crisis
An example is an investment in the Washington Post in the mid-1970s. At that time, the Dow Jones index collapsed by 45%. The newspaper’s shares fell 30 points, and their price was almost ¼ of their real value.
That’s when Buffett bought them.
In 1993, the Oracle of Omaha’s $10 million investment turned into $400 million plus $7 million in annual dividends. And by 1999, the investment had already reached 960 million rubles.
Rules of Life from the Oracle of Omaha
You can quote Buffett endlessly. From his books, interviews and articles about him, one can learn not only the postulates of investing money, but also life wisdom.
I decided to highlight some of the rules of life in a separate section.
- “The best investment is an investment in yourself. The more you study, the higher your earnings. . Buffett is known to spend 80% of his time reading and studying topics that interest him. By the way, it was the book that had the greatest influence on the formation of an eminent investor – it was Benjamin Gramm’s The Intelligent Investor, who at one time was also his teacher.
- “Improve your communication skills. It will add value to you. " In his interviews, Buffett shared that he had always been an introvert and therefore went to Dale Carnegie’s courses to cope with his shyness. As a result, Warren Buffett has become a famous person who is able to convince people and infect them with his ideas.
- "Frugality is a valuable quality". Oddly enough, the richest person on the planet leads a rather modest lifestyle. He does not have luxury villas, he does not collect expensive cars and yachts, and claims that for a comfortable life he has enough house, which he bought back in 1958, and one not the most luxurious car in 2014.
- "Make sure you are a happy person. " The investor repeatedly repeated that he likes what he does, and it is this awareness that allows him to wake up every day to work even when he is 90 years old and remain a happy person.
Here are a few more investment rules:
- "Be afraid when everyone is greedy, and be greedy when everyone is afraid. " Buffett says the best time to invest is when the market is down. Conversely, when the market rises and investors frantically buy everything, you should be very careful.
- "Hold your assets long." . As I’ve said before, Buffett is a long term investing advocate. He believes that it is impossible to extract the full potential benefit from the purchase in less than 10 years. There is no good way to get rich quick, some things just take time.
- "Don’t Invest in Leveraged Money" . Buffett is convinced that risking what you have and pursuing what you don’t need is sheer madness. Borrowing money and investing it in risky assets is never the right move. Random luck in most cases does not repeat.
- "You don’t have to follow the market daily". It would be much wiser to understand why you invested in these particular companies and trust the long-term process.
- "Don’t complicate it". Warren Buffett’s company, Berkshire Hathaway, invests in competitive assets that have good fundamentals and excellent management. The investor’s portfolio mainly contains companies that produce goods or provide services that are needed by everyone and always. These are banks, food, information technology, pharmaceuticals, transport, energy and others.
We looked at the basic rules and strategies of Warren Buffett, which helped him achieve such tremendous results in investing.
I will add the final touch so that his portrait is as complete as possible.
In addition to being one of the richest and most charismatic people, he is also the biggest philanthropist of all time: he has given more than $45 billion to charity since 2000 and plans to bequeath 99% of his wealth to the same cause.
This is a man who has achieved everything in his life and lived a happy life. I wish you to become as happy as Warren Buffett!