Although Warren Buffett has never written a book, he has shared his investment strategy with the public for over 70 years through his writings, speeches, and investments. Let’s combine his advice and wisdom to fully understand his investing system and how he mastered the stock market.
Let’s take a deep dive into the mind of Warren Buffett. He has revealed his investment strategy and how he has mastered the market through his Berkshire Hathaway annual letters, question and answer sessions at shareholder meetings, and editorials he has written for the media, along with his speeches. His teachings have been transparent, and all his buy-and-sell decisions are public information. What are the repeating patterns I see?
The success of an investment career often lies in adherence to a set of guiding principles. Following these ten principles can generate exceptional returns and navigate the complex investing world.
1. Think Long-Term
“Someone’s sitting in the shade today because someone planted a tree a long time ago.” – Warren Buffett
A crucial aspect of a successful investment strategy is a long-term focus. Assess a company’s intrinsic value and determine if it’s a good investment for the long haul. Taking a long-term perspective can avoid the emotional roller coasters that often accompany short-term trading. A prime example of long-term thinking is the investment in Coca-Cola in 1988. Despite short-term fluctuations, the investment has yielded remarkable returns over the years. He wants to buy and hold a company forever; that is his first filter; he believes that people will always want to drink Coca-Cola.
2. Invest in Quality Businesses
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
Investing in high-quality businesses with substantial competitive advantages or “economic moats” enables them to maintain or expand their market share over time. Investing in such companies can reduce the risk of losing money due to business failure or industry disruptions. The acquisition of See’s Candies in 1972 demonstrated this principle, as the company’s strong brand and customer loyalty made it a lucrative long-term investment. He likes companies with brands and business models that own their market niche, making it difficult for anyone to enter their market and beat them at their own game.
3. Management Matters
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” – Warren Buffett
The quality of a company’s management team plays a significant role in its ability to grow and succeed. Look for capable, honest, and shareholder-oriented managers who understand the business well and have a proven record of creating shareholder value. The leadership of Berkshire Hathaway’s subsidiaries, such as Ajit Jain at Berkshire Hathaway Reinsurance Group, exemplifies this principle. Buffett believes excellent company management has an enormous intrinsic value and an edge, but this is only half the battle for investment success. If the business model is terrible, even good management can’t help it.
4. Margin of Safety
“Price is what you pay. Value is what you get.” – Warren Buffett
Seek a margin of safety when investing, which means buying a stock for less than its intrinsic value based on discounted future cash flows. This cushions against potential losses if the investment doesn’t perform as expected. The risk of permanent capital loss can be minimized by seeking a margin of safety. The investment in Washington Post in the early 1970s is a prime example, as the stock was purchased at a significant discount to its intrinsic value. Buffett wants a limited downside in stock price based on the underlying business value but an unlimited upside based on the projected growth of profits.
5. Patience and Discipline
“The stock market is a no-called-strike game. You don’t have to swing at everything–you can wait for your pitch.” – Warren Buffett
Patience and discipline are essential for successful investing. Wait for the right opportunities and hold cash when attractive investments are scarce. By remaining patient and disciplined, hasty decisions that might lead to poor investment outcomes can be avoided. The investment in Apple in 2016, after years of observing the company, showcases the importance of patience and discipline. Buffett believes in raising cash when the stock market is overvalued and deploying it during a stock market crash, financial crisis, a bear market, or if he finds an undervalued company.
6. Diversification
“Diversification is a protection against ignorance.” – Warren Buffett
While diversification is often seen as a protection against ignorance, it’s still essential for most investors. Buffett thinks the best thing for most retail investors to do is buy and hold the S&P 500 index if they aren’t interested in doing the work to invest in individual names. Holding a diversified portfolio of stocks can help reduce the impact of any single investment underperforming or failing. Generally, investors should hold at least 20 different stocks in their portfolio. Berkshire Hathaway’s investments in various industries, including insurance, utilities, and consumer goods, highlight the importance of diversification.
However, Buffett keeps his entire net worth in his own company, Berkshire Hathaway. Then he diversifies Berkshire’s business and portfolio for safety.
7. Understand the Business
“Never invest in a business you cannot understand.” – Warren Buffett
Before investing in a company, understand its business model and how it makes money. Understanding the underlying business can make better judgments about its prospects and the risks involved in investing in it. If a business is challenging to understand, it’s best not to invest. Avoiding complex investments like derivatives showcases the importance of understanding the businesses one invests in. Your edge in investing is what you know and understand. Getting outside your circle of competence in the investing world is dangerous.
8. Focus on Value, Not Price
“Whether socks or stocks, I like buying quality merchandise when it is marked down.” – Warren Buffett
Focusing on the value of a business rather than its stock price is critical. Numerous factors unrelated to the company’s underlying value can influence a stock’s price. By focusing on the intrinsic value of a business, more rational investment decisions can be made, and getting caught up in market hype can be avoided. The acquisition of Burlington Northern Santa Fe Railroad in 2009 is an example of focusing on value, not price, as the railroad’s long-term value outweighed its acquisition cost. A low-priced stock can be a terrible value, and a high-priced stock can be a fantastic value. Price alone does not reflect value. The fundamentals of the business are where the value is. Look at profit margins, cash flow, quality of management, competitive advantage, brand value, growth rate, and the industry’s health to understand the actual value.
9. Ignore Market Noise
“Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.” – Warren Buffett
The stock market can be volatile and unpredictable, with prices often driven by emotions and short-term news rather than long-term fundamentals. Ignoring market noise and staying focused on the investment strategy is essential. By doing so, better decisions can be made, and the emotional ups and downs of the market can be avoided. Despite market fluctuations, Berkshire Hathaway’s history of buying and holding stocks for the long term exemplifies this principle. Patience in the market is an edge, as you must have the ability to follow your investment strategy to allow it to play out over time. No investment system will work if you can’t follow it with discipline.
10. Learn from Mistakes
“I make plenty of mistakes, and I’ll make plenty more mistakes, too. That’s part of the game.” – Warren Buffett
No investor is perfect, and mistakes are inevitable. The key is to learn from those mistakes and use them to improve the investment process. By analyzing errors and understanding what went wrong, they can be avoided in the future, leading to better investment decisions. Embrace a mindset of continuous learning and self-improvement to achieve long-term success. The sale of Berkshire’s stake in Tesco in 2013, after acknowledging it as a mistake, demonstrates the importance of learning from errors and adapting investment strategies accordingly.
“The— the dumbest stock I ever bought— was— drum roll here— Berkshire Hathaway. And— that may require a bit of explanation.” – Warren Buffett told Becky Quick on CNBC.
Buffett tells Becky in 2010 that his holding company (presumably with a different name) would be “worth twice as much as it is now” — another $200 billion — if he had bought a good insurance company instead of dumping so much money into the dying textile business. [1]
The most significant difference between most successful investors and those who fail is that they keep repeating the same mistakes over and over instead of learning from them.
Key Takeaways
A successful investment strategy involves a combination of principles that emphasize long-term thinking, quality businesses, and rational decision-making. Consistent success in the stock market can be achieved by adhering to these principles and remaining patient, disciplined, and focused on value. While there are no guarantees in investing, following these principles can help navigate the complex investing world and increase the chances of achieving long-term financial success. The stock market rewards those who are patient, disciplined, and committed to learning from their experiences. Once you have an investing edge and understand it then execution over the long-term is the last piece of the puzzle.