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“Someone's sitting in the shade today because someone planted a tree a long time ago.”
Amongst the many quotes popularised by Warren Buffett, the above was one of the standouts as it fully captures the how and why of Warren Buffett’s investment strategy.
Some people do not yet understand why we put Buffett on a pedestal in investing. Yes, he is one of the world's most successful investors and one of the best stock pickers. Yes, he has a net worth of $104 billion as of the date of writing.
But more than these internationally known facts, we imitate Buffett’s strategy because we have seen his method work for ourselves and our VI community.
Why Warren Buffett
At 11, Buffett took the first step in his investment path by buying three shares of Cities Service, a natural gas company, for USD38 per share. He was then able to grow his portfolio and, along with it, his net worth which is at USD125 billion as of March 2022.
Now, the Oracle of Omaha (as he’s known) has large investments in several huge and well-known companies, such as Amazon, American Express, Apple, Bank of America, Coca Cola, Dairy Queen, IBM, Kraft Heinz, and Wells Fargo, among others.
It’s also not a secret that Buffett owns Berkshire Hathaway, a company with a market capitalisation of USD784 billion as of today.
We could, therefore, conclude that Buffett’s way works. Otherwise, his net worth and portfolio as a value investor would be nothing to gush about.
Fortunately, Buffett’s investment strategy has been disclosed so we can analyse the justifications behind his investment decisions. So, what is his strategy? How can you invest like Buffett?
The Buffett strategy – key principles
While Buffett’s mind is at times an enigma, the key principles of his investment strategy have stayed grounded for the last five decades or so. His approach to investing has evolved over the years to differ from his mentor and the first value investor, the late Professor Benjamin Graham.
Graham picked undervalued businesses by their book value – which means that he would pick up the books of the business and plough through them in detail to dig out information not apparent to the rest of the market. This gave Graham an edge by buying businesses that owned more stuff than its trading price on Wall Street.
Buffett’s investment strategy has evolved from an original “Grahamian” style to something that looks to invest in high business quality. He uses his skills to assess a business’s competitive edge, enduring business strengths, and capacity for growth, all this on top of management quality.
Value investing – the Buffett way
Value investing could sound intimidating at first, but this approach is actually easy to understand.
Let’s break the phrase down. First, it is about investing, meaning it’s a way for you to make profits. Second, it focuses on the value of a stock, meaning it doesn’t care much about daily market activity but about a stock’s potential to generate revenue in the future.
In other words, Buffett’s strategy is unlike a trader’s. He doesn’t guard the market. Why not, you ask? It's because the market does not always reflect the true value of stocks.
A stock can be sold at a higher share price (for example, USD80) than its real value (say, USD71). It can also be sold at a lower price (for example, USD35) than its intrinsic valuation (say, USD43).
What value investors do is assess a stock’s real value vis-à-vis the price it’s currently sold. If they chance upon a stock with a high intrinsic value but a low share price, they purchase this stock.
Of course, there are risks with value investing as with other investment strategies. However, fret not because there are ways for you to become a successful value investor like Buffett.
Buffett’s value investment tips
Here are the top three pieces of advice practised by Buffett (and other successful value investors) when making investment decisions.
1. Look away from the market
We can’t emphasise this enough: The market doesn’t always accurately reflect a stock’s true value. Focusing on the market’s daily movement will not only compromise your time at work, with your family, and for yourself, but it will also throw you down into the abyss of anxiety.
Buffett himself does not follow popular market trends. He couldn’t care less about new IPOs (Initial Public Offerings) or new trendsetters. In fact, he publicly showed disinterest in what seems to be today's most popular investment option, cryptocurrencies.
What Buffett does, and what you can do to not be swayed by the bandwagon, is to invest within his “circle of competence.” This means investing in what you know. For example, if you are competent in transportation models, you should consider looking at companies in this industry. If you have experience in F&B, check if the top-performing restaurant chains you’re familiar with are listed.
And always, remember to stay committed to the companies you invest in. Think of value investing as a marriage: You marry someone in hopes of being with them for years to come and because you believe they will add value to your life in the long run. Before marrying them, you evaluate if they’re really who you want to spend the rest of your life with. You just don’t point at any stranger and propose marriage, do you?
2. Acquire knowledge
Value investing is not a sprint but a marathon. You can’t expect to know a stock’s valuation overnight and by copying what other investors are buying or selling. If you’re serious about value investing, you ought to start building knowledge.
What knowledge should you have? First, you need to know how to determine a stock’s valuation. Second, you need to learn how to pick companies with a high valuation.
Fortunately, opportunities to learn value investing abound in Singapore. The excuse “I got no time” is no longer acceptable as our movements are currently restricted by the pandemic. Attending a two-hour online class won’t take up much of your day.
Value investing is not a blind guessing game where you desperately pray that the stocks you bought gain value overnight. It doesn’t even require you to monitor your portfolio day in and day out. It’s becoming confident in the stocks you’ve picked and re-evaluating them bi-annually or annually.
But how do you become confident in picking stocks?
Buffett has this to tell everyone who wants to do value investing: read, read, and read. Buffett himself spends about five to six hours a day reading.
Knowing the business model of companies, as well as the current and projected landscape of every industry, will help you discover great investments and build a growing portfolio.
3. Get a grip on your emotions
Beginning investors often get too excited to make money from the stock market that they tend to be overwhelmed with emotions. Fear, greed, and envy are what value investors don’t want to encounter as having any of these three usually leads to irrational decisions.
Several studies have shown that women are more successful investors than men because of one simple reason: women don’t let their emotions pressure them into making investment decisions. Women, studies say, are calmer and exercise logical thinking before buying or selling.
Men, on the other hand, tend to be greedy once they hear of a friend or a relative making money from a specific stock. At times, they even borrow more money to invest without thoroughly evaluating if the returns would really be consistent in the long term.
Most investors also panic whenever a stock price drops or soars. This fear usually drives them to immediately take action without first weighing what the price change means or whether it’s just a one-time event.
We also often fall victim to envy. When we see others publicising their gains on social media, we immediately buy the stock without properly examining whether it’s a good buy or whether the share price is consistent with its intrinsic value.
Emotions don’t have any place in a value investor’s success. To blindly follow what others are saying isn’t similar to making informed decisions. Follow only when you have done your calculations and you have conviction about the stock’s potential.
Don't plant a tree just to uproot it in a few months or years, just because others tell you to. Plant a tree because you wish to see it grow and use its shade.
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Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. Please do your own due diligence.
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