Be a Smart Investor, Warren Buffett’s Way

“Price is what you pay. Value is what you get.” – Warren Buffett

Every investor has a dream to become successful like Warren Buffett and be the richest person in the world. But rarely do these investors follow their icon’s mantra (advice) conversed through television interviews, books, periodic journals, etc. It is worthwhile to pay heed to Buffet’s stock investing tips. InvestmentYogi calls them “Warren Buffett’s 9 Mantras of Investments”. This knowledge on value investing will drive investors to make sound investment decisions.

Buffet’s Mantra 1: Invest in quality businesses, not in stock symbols.

“If a business does well, the stock eventually follows.”- Warren Buffett

Most investors don’t analyze the business they invest into. They simply follow the symbols or brands of successful corporate houses. The best example is the Reliance Power IPO. When the IPO of Reliance Power was announced, many investors rushed to subscribe to it with the main reason that it had the brand name ‘Reliance’. However, the stock was overvalued at the time of IPO and investors made a considerable loss after the stock was listed on the stock exchange. Talking of IPOs, one needs to do considerable research about the concerned company, it’s past performance, how will the IPO money be utilized, details about the company management, and when would the operations commence so that company starts generating profits.

As, Warren Buffett states, “An investor needs to buy the stock as if he is buying the whole company down the road”. Investors are also expected to be acquainted with the following before buying the company stock:
What are the company’s products?
How consistent is its products’ sales?
How receptive is the company to change in consumer trends?
Who are its competitors? What distinguishes it from them? What is the company’s USP?
What would be the most worrying thing (risk) about owning such a company’s stock?

Buffet’s Mantra 2: Don’t invest for ten minutes if you’re not prepared to invest for ten years.

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” -Warren Buffett

Investors feel panicky when they track share prices continuously. Share prices are quite volatile in the short-term. Below is an illustration of the share price of Reliance Industries Limited to better understand the importance of staying away from short-term betting on share prices.

Now, if an investor had invested in the same stock for the long term (assume 10 years), its price movement over the period can be depicted as follows:

From the above 2 graphs you can clearly see that staying invested in a value company will pay you rich rewards over a long-term period, unlike short-term investments that are prone to constant price fluctuations.

Note: A smart investor needs to also think before selling an investment that may be in a loss due to certain economic factors but has tremendous potential to rise in future.

Buffet’s Mantra 3: Scan thousands of stocks and look for screaming bargains.

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” -Warren Buffett

stocks A smart investor needs to identify stocks of a company that have great potential to grow in years to come. Most investors buy a stock when it is extremely high because it’s in demand. The key is to identify stocks which have potential to grow and are available at a cheap or reasonable price.

Such acumen can be achieved by scanning the company’s annual financial reports, understanding its vision and mission statements, its business cycle and business process, long term plans, etc.

Essentially, it means taking some time out to carefully understand and analyze the company and its business. Investors also need to keep updates of their selected companies and sector news on a regular basis. Information about a company is readily available through secondary sources such as journals, economic newspapers, television, etc. Many a times such secondary sources are sufficient for analyzing and arriving at a decision for investment.

Buffet’s Mantra 4: Interpret how well money is being utilized by the company’s management

“Beware of geeks bearing formulas.” -Warren Buffett

The money available to the company’s management is called capital of the business. The capital comprises of equity and long-term debt of the company. The success of any business depends on how well its management uses its capital. Such an analysis can be made with the help of 2 ratios:- Return on Equity (ROE) and Return on Capital Employed (ROCE).

ROE = It measures a company’s profitability by revealing how much net profit a company generates through shareholders’ equity.

Return on Equity = Net Profit/Shareholder’s Equity

ROCE= It indicates the efficiency and profitability of a company’s invested capital.

Calculated as-

EBIT
= ___________________________________
Total Assets – Current Liabilities

EBIT = Earnings before interest and tax deductions.

A smart investor must interpret the company’s financial statements and understand the quality of return on his investment.

One needs to search and invest in companies with good returns on capital invested while employing little or no debt. This means that ROE and ROCE should essentially be the same.

Buffet’s Mantra 5: Stay away from the so called “glitter” stocks.

“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” -Warren Buffett

There are thousands of stocks traded each day on Sensex and Nifty. A smart investor has to find the best out of the available investment options. There are stocks that have high trading volume, extreme movements in their price (either up or down), or are constantly in news.

A smart investor should examine whether the stock-in-news has some real value or is just glittering at the moment.

Example- Remember the Satyam fiasco? The stock was glittering for many years and was a hot pick among investors and analysts alike until its accounting fraud surfaced in 2008 when Ramalinga Raju (the company’s mentor) himself confessed to the crime. The company tampered its annual reports and fooled investors for years, all the time being ‘A-listed’ on national stock exchanges.

Although the episode is behind us now, it is wise to do our homework before investing in each and every company. You would also be wise to diversify your investments across sectors and asset classes, which will give you the needed cushion from loss from any one investment.

Buffet’s Mantra 6: Wait for fat pitch then decide what to do with it.

“Value is what you get.” -Warren Buffett

Wait….wait….and wait until everything is in your favor while buying a stock. These are the stocks with the highest chance of being successful and making you money year after year. To be able to do this effectively, one needs to master the below steps as suggested by Warren Buffett.

1) As mentioned earlier, invest in stocks which are not glittering on investment magazines or recommended by stock analysts/editors on popular television channels. Perform your own research then make vital investment decisions.

2) After identifying great businesses to invest in at a fair price, buy a “meaningful amount of stocks in them.” It means hold only a limited number of companies in your portfolio; Holding excess stocks results in lower returns on your overall portfolio and spending more time to keep track of the same. This may also add considerable risk as it is not feasible for an individual to diligently observe all companies in his/her portfolio. Ideally, one should limit the number of stocks in his/her portfolio to 10-15. This way, there is an advantage of your portfolio not being cluttered.

3) Buffet elaborates about knowledge and confidence. According to him, one must require the knowledge of selecting the right stocks by careful research and also build confidence in one’s decisions. Market will test your patience to reach the expected returns. So, you need to stay firm with your investment decisions during volatile trading sessions. Do a good amount of homework and keep faith in your research and decisions.

Buffet’s Mantra 7: Calculate how much money you will make, not whether the stock is undervalued or overvalued, according to some academic model such as the discounted cash flow.

“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” -Warren Buffett

A smart investor needs to set an eye on expected returns from particular stocks in the long term and calculate the entry and exit prices of invested companies. This requires thorough research and analysis of the company’s available data. Buffet recommends being one’s own analyst to profit from investing in stocks.

Mutual funds Buffet’s Mantra 8: Remove the weeds and water the flowers — not the other way around.

“Someone’s sitting in the shade today because someone planted a tree a long time ago.”- Warren Buffett

One of the best practices according to Buffet is to sell loss making stocks during a bull run and buy the winner stocks during a bear hug. The amount realized by discarding loss making stocks can be utilized to invest in stocks with future growth potential and there by achieving better returns.

Buffet’s Mantra 9: Become a conscious investor.

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”- Warren Buffett

Most of the time investors make little progress due to insensible investment decisions. Their decisions are based on emotion, hope and wishful thinking without carrying out proper research and analysis.

It’s necessary for a smart investor to think logically while investing and performing research. You need to keep on asking yourself why you want to invest in a particular company and eliminate decision making based purely on intuition, emotion and herd mentality.

Due diligence before investing in a particular company saves you from the worry of your money being tied-up in companies and businesses that you have little or no knowledge about. Follow the sound advice provided by Warren Buffet – avoid the noise and glitter, do your own research, and constantly update your knowledge and stock picking skills. In short, be a smart investor!

Source : investmentyogi.com

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