12 Words of Wisdom from Warren Buffett

Don't Gamble

Warren is more interested in making sure that an investment results in the return of capital as well as the return on that capital. In other words he hates risk and gabling. He wants to make sure he takes the shots only when he knows what he is getting into. One of this famous quotes is that the No. 1 Rule of investing is to never lose money and the No. 2 Rule is to never forget Rule No. 1. Risk comes by not knowing what you are doing so always manage your risk.

 

Margin of Safety

Even when you have done you due diligence and narrowed down on a particular stock there is still a chance that you will make a mistake and the price will still fall further. So you should always have a margin of safety when you buy an investment. Have a purchase price so attractive that a mediocre sale becomes profitable. Look at companies which have sales and revenues on an upward trajectory. Buy companies with high profit margins. Look for retained earnings and good equity build-up. Then try to buy at a price which is closer to the book value. Avoid companies with a lot of debt. Come up with an intrinsic value of a business you buy based on the cash flow of their future earnings discounted to the present value.

 

Circle of Competence

Buy what you know. Stay invested only in companies you know best about based on your own circle of competence. Never buy a stock because someone else recommended it to you. Make your own decisions.

 

Do your Homework

You should be able to explain to your grand mother what business you are buying into. Make sure you do your analysis on fundamental, technical and quantitative methods. Come up with an intrinsic value of the business based on scientific techniques. If the company facts change then change your opinion quickly. You should Buy and Hold buy never Buy and Hope.

 

Be Contrarian

Mr. Market will usually come to you to purchase your farm or sell you his. Try to purchase from him when the over all conditions are most gloomy. Be Greedy when everyone else is fearful. Such buying opportunities come once in a while and when they come it does not rain it pours and make sure you have your buckets ready for that day. Avoid the herd instinct. Be confident but never over confident. Avoid complexity and keep it simple. You only have to do a few things right as long as you don't do too many thing wrong.

 

Buy Good Businesses

Time is a friend of a good business and an enemy of a mediocre one. So make sure you buy the best in class out there. It is always better to buy a wonderful company at a fair price rather than buying a fair company at a wonderful price. Buy companies that have a product or a service which is the best of the best or in other words the business has a moat which other competitors do not possess.

 

Keep Good Company

Always associate your self with people who are smarter than you. Even if you don't know where you are going you will still reach the destination just by sticking around with them. Buy companies with management which is honest. Management that takes rational decisions and returns capital to shareholders by dividends or stock buybacks.

 

Be an Investor

Be ready to buy a company that you are willing to hold for the next 10 years. If you don't plan to hold a company for 10 years don't even spend 10 minutes wasting your time on it. Invest as if you can hold the company even if the markets remain closed for the next decade. Never trade in and out. Remember that motion in investment causes high transaction fees and that eats into the returns. Hence sometimes it may be better to buy an index fund.

 

Buy a business

Buy into a stock as if you are buying into that business. Know everything there is to know about the company. Be able to read into the financial statements of the companies you invest in. Be able to know what markets they operate in and how the market forces affect their business.

 

Fail Fast

Try to learn from your mistakes. It is ok to be wrong but never ok to stay wrong. If you make a mistake just admit it cut your losses early and move forward. Never worry or dwell in the past. Just make sure you learn from your mistake and treat the loss as the tuition for that learning. Remember never make the same mistake twice. Time is of essence so know the difference between what is important and what is trivial. Think outside the box for novel solutions to problems. Never settle for status quo. There is always a better way to do things.

 

Compounding is like Magic

Warren bought his first share on Mar 11 1942. He feels that if he had invested that money in an index fund which invests the profits and hence compounds the gains the same investment would have been much more. He strongly believes in the power of compounding.

 

Don't Overdiversity

Risk can be reduced when you diversify however make sure there is a limit to diversification. Ignorance is not an excuse for diversification. Try to scale in and out of your positions. Invest a little amount every month. If you are not sure what to invest in then always fall on a low cost S&P index fund. Diversify into growth and value. Diversify into stocks and bonds. The key is to know what you are invested in at all times.