Warren Buffett is widely regarded as the greatest stock market investor of all time. Had you invested $500 with the guru back in 1965, that money would have been worth about $22m at the end of last year.
Interested to know what Buffett’s number one rule in investing is? Read on and I’ll tell you.
A simple rule
Given Buffett’s incredible level of success in the stock market, you might expect his number one rule in investing to be complicated. But it isn’t.
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“The first rule of investment is don’t lose”, he says. It’s that simple.
Rule number one: never lose money. Rule number two: Never forget rule number one.
Warren Buffett
Risk management’s the key to success
Now, you’ll probably agree that it’s a bit of a strange one. Because everyone loses money in investing at times.
Buffett’s often lost substantial amounts of money on certain stocks. For example, he lost hundreds of millions of dollars on Tesco shares when his investment in the company backfired.
But I get what he’s trying to say. And that’s risk management’s really important if you want to be a successful investor.
If you want to generate strong returns over the long term, it’s crucial to minimise large losses. After all, if a stock falls 50%, you need to generate a return of 100% just to break even. If it falls 80%, you need a 400% return to get your money back!
Following Buffett’s rule
In terms of strategies that can help investors follow Buffett’s rule, there are several worth highlighting.
One is diversifying capital across many different stocks. No one ever gets all their stock picks right. But by taking a diversified approach to investing and buying 20 or more stocks for our portfolios, we can dramatically improve our chances of being successful in the stock market. Even if a few stocks perform really poorly, the chances are the basket of stocks will do well over time.
Another is paying attention to a stock’s valuation. This doesn’t necessarily mean buying the cheapest stocks out there (Buffett has said it’s better to buy high-quality stocks for an average price than to buy average stocks for bargain prices). But it does mean focusing on stocks that have reasonable valuations and are unlikely to lose 80% of their value in the future.
A stock to look at now?
One UK stock I believe is trading at a very reasonable valuation today is Coca-Cola HBC (LSE: CCH). It’s a major bottling partner to the Coca-Cola Company (one of Buffett’s largest holdings).
At present, this stock trades on a forward-looking price-to-earnings (P/E) ratio of 13.1 using next year’s earnings forecast. I see that as quite a low valuation, all things considered.
This is a business that offers both long-term growth potential and defensive attributes. It’s also a company with a fantastic dividend growth track record (more than 10 consecutive dividend increases).
Of course, this stock does have its risks. Changing consumer tastes/preferences (ie the shift to more healthy drinks) are one. Economic and geopolitical turbulence is another (some consumers are boycotting US brands at present).
But at today’s valuation, I see a lot of appeal in this stock. I believe it’s worth considering for a diversified portfolio.
