Warren Buffett is an icon for every investor. He is an institution to learn investing tactics from. Here are some of the central tenets of his trade that can help you build your dream investment portfolio.
- Business Tenet
This is one of the most important pillars of Warren Buffett’s investment strategy in stocks. Instead of going on a buying spree, you should identify the companies whose business you understand. It simply means that if you are unaware of a company’s business, or it is hard for you to comprehend the business and potential risks involved, you should avoid investing in such a company.
E.g., In the early 2000s, the stock markets hit a massive crash largely owing to the bubble burst of many internet companies. But irrespective of the hype, Warren Buffett didn’t invest in internet companies as he didn’t understand their business completely. Hence, he saved himself from a significant loss.
- Management Tenet
The success and long-term growth of a business depend on its management. But how can you measure the capability of the top management? Of course, by looking at their past track record. Even in adverse market conditions, sound management builds trust in the organisation. Hence, it is good practice to invest in companies with strong management.
E.g., When Mr N. R. Narayana Murthy resigned from the Board of Infosys in 2011, investors were shocked, and the stock lost a lot of value in the market. On the contrary, to rebuild the investors’ trust, Infosys had to reappoint him as an Executive Director in 2013. Hence, reappointing a trusted leader brought investors’ confidence back.
- Financial Tenet
While there are many financial indicators that stock market investors follow, here are the key indicators that suit Warren Buffett’s trading style:
➢ Past Performance (Return on Equity)
A company that adds value for its investors is worth investing in. So, if you want to invest in a company, choose the one that has provided high ROE during the past 5-10 years.
ROE = Net Income ➗ Shareholder’s Equity
➢ Debt – Equity Ratio
According to Warren Buffett, you should invest in a company with a lower D/E Ratio. It means that the company has to pay less interest against outside liabilities. It automatically increases the shareholder’s income.
D/E Ratio = Total Outside Liabilities ➗ Shareholder’s Equity
➢ Profit Margins
Following Warren Buffett’s investment style, one should prefer investing in a company that earns higher profits. It ultimately converts into dividends or increases the intrinsic value of the company.
Profit Margin % = Net Income ➗ Net Revenue ✖ 100
- Value Tenet
Warren Buffett was always known for value investment. Hence, this is the most important tenet. Here are the questions you should answer to understand the intrinsic value of a business.
➢ Years in Running: A business that has operated for over ten years in the market is more stable than a newer business endeavour.
➢ Competitive Advantage: You should invest in a company that provides a distinguished product. This gives a substantial competitive edge to the business that converts into profits.
➢ Cost-effectivity: If a company is available at much cheaper rates in the market compared to its intrinsic value, it’s a must-buy.
From a young investor who bought his first shares at the age of 11 to the second-richest man on the planet, Warren Buffett’s journey is an inspiration. Whether you are a budding investor or a well-established one, you can always learn something important from his investment style.