Investing Tips from Warren Buffet

I just finished listening to the Warren Buffet interviews I posted the other day.  I’ve always heard good things about Warren, about how he’s a really nice guy and all, but after watching the interviews he really struck me as a genuine, cool guy.  Oh, and I guess it’s really awesome that he’s giving billions to charity.  He also gave some pretty useful tips for
investing in the second interview, including a test he uses to determine whether an investment is worthy of his money.

Buffet learned how to invest money from a man named Ben Graham.  Ben Graham practiced what is called “value investing.”  The idea of value investing is to invest in a company when you think that company is undervalued, and wait for the stock market to correct the mispricing.  For instance, if you look at a company’s earnings, debt, growth rate, potential future growth rates, etcetera and determine that it is worth $15 billion when the stock price only implies it is worth $10 billion, then you would purchase the stock.  Buffet says he learned a few key principles from Mr. Graham:

• First, learn what a business is worth.  Don’t waste your time with stock charts and volume and all of that junk.  Just focus on finding out the intrinsic value of a business.
• Next, know that the stock market is there to instruct you, not serve you.  You should take advantage of stock prices when they are out of line with reality.
• Finally, always have a margin of safety.  Even though you might have picked a stock which is undervalued at the time, bad news can emerge before the price has adjusted and the stock might have a new intrinsic value.  So don’t pour all of your net worth into a stock just because it’s undervalued at the time.

This differs from a more risky approach (in my opinion) called “growth investing,” where you simply try to pick a company that is going to be the next big thing with no regard for its intrinsic value.  I feel it is a much safer bet to value invest than growth invest, since growth investing is often no more profitable than betting on horses, although it sure is a lot of fun.

Buffet also has a test that he uses before he puts any of his money into a particular investment.  The test is as follows:

1. The business must be a business he understands.  Buffet does not own many technology companies partially because he doesn’t understand the business very well.
2. The business must have an enduring competitive advantage.  This means investing in a company that sells a product in an over saturated market of substitutes is a big no-no in this regard, unless that company can sell at a very low price.  Investing in a company that is selling a product that is wildly popular and has a brand new patent, however, is a much better idea.
3. The business must have good management.  Buffet says that the business must have a management that he trusts.  This is especially important today with so much corruption going on at the corporate level.
4. The business must be selling at a reasonably attractive price.  Buffet states that this is the least important of the four points in his test, but still a very important point to make.  A company selling at well more than its intrinsic value on the stock market, no matter how great the company, is still a poor investment unless you know for sure it will grow at a lightning fast rate.

These are very useful investing tips that I think every investor should keep in mind if he/she decides to pick stocks.  However, I still recommend, especially for those inexperienced with investing, simply keeping money in a S&P 500 index fund with a low expense ratio and holding on to it for a very long time period.  Over the long term, the only two people I can think of who have beaten the S&P 500 are Peter Lynch (Magellan Fund) and Warren Buffet (Berkshire Hathaway)… so if I were you, I’d take the steady, approximately 10-11% return of the S&P 500 over time.