Investing like Warren Buffett: advice and guidelines

Editor’s note: This article was first published in March 2011. The description of Buffett as the best investor today refers to 2011.

Warren Buffett learned from the greatest investor of all time, Benjamin Graham, author of The Intelligent Investor. When Graham started investing in the stock market, technical analysis charts probably didn’t even exist yet, and that hasn’t stopped his pupil from following his investment advice to the letter.

Although, in the stock market as in business, the usual advice is to leave emotions out of it, the truth is that Buffett does use passion when it comes to investing in a company. He has to be “in love” with the company, whether with its service, its profits… For him it’s like a marriage, because he doesn’t believe in buying with the idea of selling as soon as he has a capital gain. He likes to hold on to the shares and be part of the company he has fallen in love with.

Warren Buffett’s advice

1. When you invest in a company, you’re not investing in or buying a chart, or even a share: what you’re buying is part of a business, so you need to like that business. There may be companies in sectors that don’t appeal to you that you could use to make more money in a market downturn, but money isn’t everything.

2. When you invest, imagine the stock market closed tomorrow. Would you like to sit on the board of the company you’ve bought a piece of?

3. Do you understand the company’s sector? Understanding the sector will help you anticipate disastrous consequences caused by external factors. Investing in a national energy company means taking on risks from the country’s energy policy and new government regulations. Investing in Coca-Cola ensures that, whatever happens, people will keep consuming the product.

4. Analyse the manager running the company. Knowing a ship captain’s strengths and weaknesses tells you roughly how far the ship can sail. Competent, bold and principled: three qualities that, in the hands of a company’s manager, help it move forward.

5. Invest in businesses that are profitable and easy to understand. You don’t know whether vehicles will still need oil in the future, but it’s very likely that they’ll still need insurance, just like homes and shops. Insurance companies carry some risks, but insurance is a product consumers need. Which company in the sector you should choose comes down to analysing its product, service, price, the captain at the helm and its ability to adapt over time.

6. Try to imagine where the company will be in 10 years. What would have to happen for it to disappear? Which companies could knock it off its leading position in the market? If you have doubts about whether the company will still be around in 10 years, it’s probably not a good idea to invest in it.

7. Be humble. The people who go broke investing in the stock market come in only two kinds:

• Those who know nothing.
• Those who know everything.

8. Don’t over-diversify. Follow five or six profitable companies. Before investing in a seventh company, consider that it might be better to put more capital into one of the six you already own (you invested in them for a reason).

9. Some investors make this mistake: to earn money they don’t have and don’t need, they risk money they do have and do need.

10. When markets fall, some investors panic and sell their shares in the company. Those who believe in the company take advantage of the drop to buy those same shares again at a lower price. That’s what comes of investing in a company you trust. If you lack that confidence, then, just as in marriage, don’t marry that company.

These are the guidelines Warren Buffett follows, inherited from his mentor. If you think about it, Buffett isn’t a short-termist and doesn’t like speculating with companies. His thinking is completely at odds with technical analysis, which makes him an investor who creates value and, therefore, the best investor walking the face of the earth today.

Further reading

• Common mistakes when investing in the stock market
• Serious investor mistakes
• Why the stock market is the most profitable investment
• How you can go broke investing in the stock market

Featured image: Aaron Friedman, CC BY 2.0, via Wikimedia Commons.