Today, billionaire investor Warren Buffett celebrates his 94th birthday.
Over many decades in the stock market, the Sage of Omaha has earned billions of dollars by investing in the shares of blue-chip companies like Apple and Coca-Cola (NYSE: KO).
Buffett has shared a lot of his investing wisdom publicly again and again. Here are three pieces of his wisdom I regularly apply to my own investing.
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1. Don’t invest in what you don’t understand
Buffett has consistently stuck to the same sorts of businesses throughout his career – and that is not a coincidence.
When asked why he has made certain investments and also why he missed out on some that would have turned out brilliantly in the end, he answer is the same. He sticks to areas he feels he understands.
Why does that matter?
Putting money into something you do not understand and therefore cannot assess is not investment, it is speculation.
2. Always think about cash flows
Does profit matter for a business?
In short, of course it does. But profit is not necessarily what many people think it is. Profit is an accounting concept and can include non-cash items. So – and we have seen this with many listed retailers over the decades – a company can be profitable yet go into bankruptcy.
Why? Cash flow.
Cash flow is the hard, cold cash coming in (or going out) of the door.
Buffett understands that very well — and why cash flow matters to investors. Indeed, one of the reasons he has spent his career investing in insurance companies is because they typically generate some cash flow today (think of your yearly premiums) but may not need to use it for decades (if you do not make a claim).
Meanwhile, spare cash flow can fund other investments – exactly the use of insurance companies’ ‘float‘ (cash that is spare, for now) that helped Buffett build Berkshire Hathaway.
3. Staying mainstream can be very lucrative
Some investors believe that the biggest returns are to be made in small, emerging businesses.
Yet Warren Buffett has mostly invested in large, well-known companies that already have proven business models.
As a small investor, I think that approach makes sense for me too.
For instance, the market for soft drinks is already massive, so Coca-Cola does not need to spend heavily to educate consumers on why or how to use its products (unlike many start-ups). But the money it has spent building its brands over decades means it now generates huge sales.
Others may want to break into the market, but strong brands and proprietary formulas give Coca-Cola a competitive advantage. That in turn gives it pricing power, meaning it can increase its profit margins without necessarily losing customers.
That is a classic Warren Buffett business. One risk I see is health concerns hurting demand (though Buffett has reached a spritely 94 while guzzling gallons of the stuff). Coca-Cola’s diversified range of products could help mitigate that.
Warren Buffett has invested in large, well-known blue-chip firms listed on the stock market — and made billions doing so. What an inspiration!
