How to Invest Like Warren Buffett
First Published date: 10. September, 2022Last Updated: 2. January, 2023Fact-checked by Adrian Müller
There are very few people out there who don’t know Warren Buffet. From learning about his multi-millions made purely from making investments, you might be interested in doing the same. If you want to learn how to invest like Warren Buffet, you’d be surprised to know how easy his strategies are.
This guide looks at how Warren Buffet invests, what kind of businesses he chooses, and his strategy. The things you learn in this article could help your career for the rest of your life. So, be sure to read attentively until the end.
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Table of Content
The Warren Buffet’s Investment Mindset
Before diving into the actual investment strategies and methodologies, investors must understand their philosophy. It’ll give you a clear framework to use when investing.
You can sum up Warren Buffet’s investment philosophy with two simple words – value investing. Value investing methodology might sound complicated, but it’s pretty straightforward.
He searches for investments that are trading below their intrinsic value. In other words, he looks for businesses valued lower than they should be. He then buys shares in those businesses and holds on to them for a sustained period.
When the market adjusts to reflect the real intrinsic value, his investments give him a significant return. However, even though it might look straightforward, putting it into practice requires discipline and knowledge. Only some investors are good at identifying undervalued shares – Warren Buffet is one of the best at this.
As a result, he understands which businesses the market is currently undervaluing. He isn’t that concerned about what the market does, either. He’s more focused on the company and looks at the businesses as a whole.
Therefore, he doesn’t get tied up with supply and demand when investing. Neither does he care whether the market will eventually value the company as it should. According to Benjamin Graham, the stock market is a voting machine in the short run. But in the long run, it becomes a weighing machine.
Therefore, Warren Buffet’s primary concern is about the business’s potential. He looks into how well it can make money, how well it’s run, and similar factors. Granted, identifying these indicators in a business takes experience and knowledge. But if investors follow the correct principles, it’s possible to achieve.
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Warren Buffet’s Process and Evaluation Criteria
We know that Warren Buffet’s fundamental principle is value investing. He finds undervalued businesses and invests in them.
He also doesn’t care that much about market sentiment. For this, identifying the right business is vital. But how do you do that? Some of it comes with experience. But there are some simple questions and identifiers investors can look for.
Performance
This one’s pretty clear. Might we say it’s even an obvious one? Company performance gives an excellent idea of how the business has done in the past. Warren Buffet looks into the company’s return on equity.
Return on Equity (ROE) is a measure of financial performance. It can help investors understand a company’s profitability and how efficiently it generates profits. When working out the ROE of a company, you must take the industry into account. The simple formula to find out ROE is:
ROE = Net Income / Shareholder’s Equity
A mistake investors should avoid is not looking into enough data. You can’t judge a company’s performance by only looking at the previous year. In most cases, this will give you a very skewed perception.
You should observe the past ten years of data at least. This will allow you to make an informed decision.
This analysis will give you enough data to truly understand how the company has performed compared to others in the same industry.
Margins
Company profit margins are another factor to consider when looking for companies. High-profit margins are always a good indication. It shows that the business is managed well and runs efficiently. Speaking of good management, this is another important criterion that we’ll touch on later.
To calculate the profit margin, you can use this formula:
Profit Margin = Net Income / Sales
A high-profit margin means its activities are returning good profits. The profit margin metric is used to judge the company’s financial health. Even the business itself will keep a close eye on its profit margin.
As such, Warren Buffet always uses profit margin as a gauge to understand the business. Like ROE, you can’t judge a company with only a single year’s data. To get a clear picture, you should look at the past five year’s financial data.
Debt
Warren Buffet prefers small amounts of debt in the company he invests in. It shows that the company’s earnings growth is generated from shareholder’s equity. The D/E ratio is easy to calculate as well:
D/E Ratio = Total Liabilities / Shareholder’s Equity
Using this formula, investors can discover what portion of the equity and debt it uses to finance the assets. A high ratio is a negative sign. It means that the company uses mainly debt to finance its activities.
If a company uses debt primarily to finance its earnings rather than shareholder’s equity, it will result in high-interest payments. Earning also becomes volatile as a result. However, if you want a more rigorous analysis, you can use only long-term debts to calculate the D/E ratio.
It helps if you are mindful of the industry the company operates. This puts the numbers into context.
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Reliance on Commodities
Think back to Warren Buffet’s philosophy. Remember that he isn’t concerned about supply, demand, or the market. Warren Buffet puts more importance on how the company is run. Also, how fast can the company make a profit?
As a result, when he invests, he looks for a differentiating factor, meaning the company should bring something unique from its competitors. You’ll notice that he doesn’t invest in companies that trade commodities.
If a company or business has something that sets it apart, it can leverage the unique selling point to beat competitors and bring in high profits. Economic advantage is everything when you’re in a very competitive industry.
For example, take Apple. It’s a consumer electronics and computer company that beats its competitors in major areas. Apple has brand loyalty, brand image, and it’s user experience. Those who buy Apple products primarily buy them for their unique advantages.
The same goes for competitors like Samsung – one of the biggest names in the Android smartphone segment.
Other Android manufacturers have access to the same Android software from Google and the same processors from Qualcomm. Yet, Samsung dominates because of its competitive advantage.
Warren Buffet calls a company’s differentiation factor its economic moat. It’s the thing that’ll provide the company with a clear advantage over its rivals in the industry.
Has the Company Stood the Test of Time?
If you look into Warren Buffet’s investment portfolio, you’ll discover a surprising lack of tech investments. That’s because he has a rule of investing in businesses that have stood the test of time. Most tech companies with an IPO haven’t been around for ten years.
He also doesn’t understand how today’s tech companies work behind the scenes. As a rule, he only invests in companies he knows and the industry he understands. Apple is one exception.
Apple isn’t a new tech company by any means. So, Apple is the most significant tech company Warren has invested in.
He puts a lot of importance into historical performance. Warren believes that past performance can give investors a good idea about how well a company can increase shareholder value.
But there’s a caveat. Strong past performance doesn’t always mean strong future performance. This is where your intuition and expertise will come in handy. You, as the investor, must realize which companies have the potential for high growth and generate profits in the future.
In other words, which companies have a high potential to increase shareholder value? Public companies are required by law to release financial statements.
To predict future performance, you can use these statements to analyze a company’s financial health and past performance. As a result, you’ll be better informed when deciding which companies to invest in.
Finding Undervalued Companies
The biggest challenge is finding undervalued companies when others aren’t underestimating a stock. This is the biggest criterion for investing like Warren Buffet. The market and other investors aren’t that good at finding undervalued companies.
Warren Buffet’s crucial skill is analyzing which companies are trading for less than their intrinsic value. This is the crux of value investing. Investors can figure it out by looking at company data.
You can determine a company’s intrinsic value by analyzing the basics, like earnings, assets, and revenue. But it’s easier said than done. One thing to remember is that, in most cases, the intrinsic value is higher than the liquidation value.
That’s because liquidation value doesn’t consider intangible assets like brand image and customer loyalty.
A business might meet all the other criteria, but whether it’s undervalued is tricky to gauge. There isn’t a reliable way of explaining how Warren Buffet does it. Of course, you will improve with experience and knowledge of the market.
It’s Not Only About the Numbers
Investing isn’t just about the numbers. Warren Buffet’s investment strategy and philosophy go beyond just looking at the financial data and past performance. He’s disciplined and also patient.
Therefore, focusing on the numbers may only sometimes give you the return you hoped for. Here are some other factors that help Warren Buffet invest successfully. If you want to learn investing like Warren Buffet, you should pay attention to these mantras.
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79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.
Investing In What You Know
The most significant learning point is investing in companies and industries you understand. This fundamental principle will help you recognize a business’s potential more. If you know the industry or the business, you’ll be able to judge a company’s potential more accurately.
In addition, if you’re a business owner, you’ll have first-hand knowledge of how things work under the hood. This will give you better insights into which companies might succeed and which companies might fail.
However, you don’t only need first-hand experience to judge the potential of a business. Remember that you should make decisions based on something other than gut feeling.
That’s why if you aren’t a business owner in a particular industry, you can still get a good feeling with a fact-based, rigorous, and systematic approach to evaluating businesses.
You don’t need to go back to school and get a finance degree to learn investing skills. There are fantastic resources like Trading for Beginners with in-depth analysis, news, and tools to help investors.
The Management Team
A business with a strong management team can hit the ground running. Warren Buffet always makes it a point to choose companies with a fantastic management team.
The management team should treat the interest of their shareholders with the same importance they treat their business’s interest.
This is important to consider if you’re thinking of becoming a shareholder. Investors must get hands-on a bit. Of course, you won’t dwell in the company’s daily operations. But taking your time to know the management is essential.
In addition, the staff will also be a good indicator of the company’s management. Are they happy working here? This gives you clues on what the management is like.
Happy staff will help a company thrive. Moreover, when a company’s culture is good, it’ll naturally attract top talent.
Conclusion
Learning how to invest like Warren Buffet is one thing. But executing the principals day in and day out is another. You must be resilient and disciplined. Many new investors get too impatient or search for a get-rich-quick scheme.
That is far from Warren Buffet’s investment strategy. There are inherent risks in investment. You’ll make some bad investments, whether you are a complete beginner or a veteran.
Although Warren Buffet has his fair share of missed and failed investments, you can’t disagree that his investment strategy worked wonders for him.
About the author – T.R. Carnegie
I am a retired investment banker who has invested heavily in energy stocks since 2005. My goal is to help people understand what is really going on behind the scenes and to provide them with the information they need to take control of their financial future. These days, I am an energy stock investor who has made money from oil, natural gas, coal, nuclear power, wind, solar, biofuels, storage, and battery technologies. In this blog, you’ll find ideas about investing in companies that will help us reduce our dependence on fossil fuels, increase access to clean energy, improve efficiency in manufacturing processes, and build products that save people money and protect the environment.
