Making a losing investment can be a crushing experience. And I bet we’ve all had them.
Sometimes, there’s no hope of recovery whatsoever, and all we can do is sell out – probably after it’s way too late to save anything but pocket change!
Warren Buffett is different. It’s rare for him to lose his shirt on an investment, and he said in the 2002 annual report for Berkshire Hathaway, the conglomerate he controls, that he expects every investment he makes to work out well. And he’s got a decades-long record to prove that most do.
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So, what’s the secret ‘sauce’? Luckily for us, he spelt out his methodology in that 2002 report. I reckon we can use his advice as a five-step approach to turbocharge our investment results in 2019 and beyond.
Conservatively financed companies
Focus on the strength of the balance sheet. Look for levels of debt that make sense and a healthy cash balance. Some, such as British super-investor Lord John Lee, tend to target cash-rich firms, for example.
I’d also look for ‘hidden’ debt such as pension obligations, lease commitments and excessive, unpaid creditors. The big no-no is over-gearing. Too much debt can go on to sink a company and your investment in it.
Competitive strength
A strong trading niche in the market can mark out superior businesses from poor ones. If a company enjoys good trading economics, it’ll probably show up in a consistent record of rising revenues, earnings cash flow and dividend payments. You’ll also likely find robust profit margins and decent-looking returns on capital and equity.
Able and honest directors
Look for directors who are good at what they do. They also need to have ‘clean’ reputations. And search for evidence that they operate with integrity.
This chimes with advice from Lord John Lee. He also suggests avoiding firms with a high turnover of directors or advisors or both. If that’s happening, there could be hidden trouble in the company.
Valuation
Good companies can make poor investments if we pay too much for them. Sometimes, over-exuberance in the investing community can drive the valuations of good businesses too high. Any correction to that over-valuation can keep the shares pegged down despite underlying operational progress.
Buffett looks for good firms selling at a price that makes sense of an investment. He pays a fair price for good businesses.
Risk versus reward
Buffett looks for more upside potential than there is downside risk. This is where the ‘art’ of investing comes in because you won’t find this out by crunching the numbers. Naturally, Buffett has a good eye for spotting such opportunities
But I will say that you probably have better judgement than you might suppose. For me, the hardest thing to learn about investing was to trust my own judgement. But if you learn your lessons along the way, I reckon you’ll have a good chance of succeeding with investing in 2020 and beyond. Good luck!
