In 1965 Warren Buffett took control of Berkshire Hathaway a struggling textile company based in New York. Over the next 57 years, he’s amazed us all by turning it into one of the most valuable conglomerates around. He did this with a fairly simple set of investing principles that investors the world over try to emulate. Here are a few tips I try to follow when making my own investments.
Stay within your circle of competence
The disciplines and sectors in which an investor has a great interest or understanding are referred to as a ‘circle of competence’. We can’t all be experts in everything, but if I’m passionate about a subject, I’m more likely to have an advantage when picking the firms to invest in. By contrast, how will I know which are likely to flourish if I don’t have at least a basic grasp of a specific industry?
Warren Buffett has been criticised for not investing in the internet boom, although he became an Apple investor in 2016. He’d consistently emphasised that he had little understanding of how technology businesses operate or, more significantly, how they earn money. Instead, he concentrated on companies that make things, such as Coca-Cola, or on finance, such as Bank of America…and eventually Apple. The company, of course, makes a lot of very popular physical things, as well as monetising the internet. And me? I’ve been interested in renewable energy for a long time, so that’s where I’m concentrating my efforts.
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Well-known investor, Peter Lynch, reiterated a similar view. “I know restaurant managers who invest in IBM, but…why they don’t invest in restaurants. They know how the business works. They know if a restaurant is profitable and what sorts of challenges they face”.
Business fundamentals
Focusing on the fundamentals of a company’s business is another crucial aspect of Buffett’s strategy. How does it generate revenue? What’s the profit margin? Is there a lot of cash on hand, or is it heavily in debt?
Investors can find the answers via a short web search. Financial statements might be intimidating (and boring) to read, but the specifics of the firm are there for anybody to view.
Buffett has long recommended investors avoid firms with a lot of debt and instead seek a lot of cash flow.
Paying down heavy debt loads will eat into a company’s earnings. However, if it has solid cash flow and cash on hand, it can weather storms (like pandemics).
The most prized virtue? Patience
Finally, Buffett is a patient man. Waiting years and years for an investment to pay off is an example of this. It might also be a matter of waiting to invest.
With one important distinction, he once compared investing to baseball. “In investing, no one’s making you swing.” He’s the first to confess that he’s made some poor investing decisions. However, when it comes to investing my own hard-earned money, it’s always best to be careful, and to wait for the right time and the right firm before making a decision.
There’s no way to be certain about any investment, but knowing the company and the industry may provide investors with a significant advantage. Patience can aid us in waiting for the ideal moment.
If it’s worked for Warren Buffett, it may well work for me.
