It has been a busy year for billionaire investor Warren Buffett. He sits on a huge, growing pile of cash and we have not seen any big deals at the Sage of Omaha’s company Berkshire Hathaway. But Buffett’s firm has been busy selling tens of billions of dollars’ worth of shares in Apple (NASDAQ: AAPL) and other companies.
Over the long term, his approach to the stock market has proven highly profitable. Here are a handful of his techniques I plan to apply to my own attempts to build wealth next year and beyond.
1. Plan to hold, but be prepared to sell
Buffett is a buy-and-hold investor. He has said his preferred holding time is “forever” and indeed he has held some shares for many decades already.
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But, as his Apple sales show, he is also willing to sell. It can be easy to become emotionally attached to a share, especially when it has done as well as Apple has for Buffett. But even as a buy-and-hold investor, one must be willing to sell if circumstances merit it.
2. Look to future customer demand
When Buffett buys shares, he tries to tap into long-term demand trends. Rather than chase a current fad, he is looking for industries likely to benefit from decades of customer demand, whether for soft drinks or computers and smartphones.
3. Focus on value, not just finding great businesses
Value as an idea is understood differently by different investors. Some think it is all about buying something at a low price. Buffett looks at whether the cost is less than the likely ultimate gain. As he says, “price is what you pay, value is what you get”.
Essentially, Buffett is looking at a share’s discounted cash flow. He wants to buy something at a price he thinks is lower than its likely future cash flow, discounted for the opportunity cost of tying up money and also priced with a margin of safety.
That is why I would be happy to buy Apple shares, but not today. I think it is a great business, with a strong brand, large installed user base and lucrative services model. But its current price-to-earnings ratio of 41 offers me too little margin of safety for risks like low-cost Chinese brands’ improving product quality eating into Apple’s share of the smartphone market.
4. Don’t waste the dividends
Buffett’s empire generates billions of pounds each year in passive income, thanks to dividends. Does he fritter this away? No – he reinvests in in building Berkshire’s business.
That approach is known as compounding. Buffett compares compounding to pushing a snowball downhill, with the snow picking up more snow as it goes. Reinvesting dividends can mean a growing portfolio that in turn generates even more dividends.
5. Spread the risk
Buffett has mentioned tax treatment as one possible driver for selling some of his Apple holding.
Whatever his reasons, one benefit is that it means his portfolio is now less dominated by one share. No matter how great a company is, it can run into unforeseen difficulties.
With billions to invest – or just a few hundred pounds – smart investors always stay diversified.
