7 Secrets to Investing Like Warren Buffet
When considering making a large purchase, calculate the dollar amount you’d be sacrificing given 10, 20, or 30 years of compounding growth on that initial investment. Then decide if it’s worth it.
Grow and compound your savings, not just your investments.
The interest from debt is guaranteed. The interest from investment is not guaranteed.
Rule #1: Never lose money.
Rule #2: Never forget Rule #1.
Always have at least three months of liquid savings as an emergency fund to cover your living expenses.
Ideally, insurance should cover 10 years of your annual income and a sizable amount of medical insurance for everyone in the family.
If you’re investing in stocks, you should look for these 5 qualities:
- Profitable business
- Lots of loyal customers
- Always ahead of trends
- Market leader
- Good growth potential
Analyze the products and services you and others spend the most money on and follow that trail to the businesses responsible for those products and services.
Should you choose to construct your own portfolio, you must stick to the businesses and industries about which you know very much. In other words, stick to your circle of competence.
You want to invest only in companies that have an economic advantage over others. They need to have an economic moat.
Companies with strong brands are likely to possess a durable competitive advantage.
Accounting is the language of business.
A balance sheet is a record of what a company owns and what it owes.
Current assets are assets that can be used or up or readily turned into cash. Current liabilities are liabilities owed within a year.
Net Worth or Equity = Assets - Liabilities.
Inventory refers to the product of a business.
Accounts receivable is the money a company expects to receive from its customers (delayed income).
Accounts payable is money a company needs to pay its suppliers.
Total debt ÷ total equity = the debt-to-equity ratio. A good debt-to-equity ratio is less than 50%.
The income statement summarizes all the money a company makes and all the money it spends. What is left is the net amount it saved (earned).
Net profit is the final amount of profit shareholders can expect to be theirs.
Return on equity (ROE) demonstrates how well a company uses its equity (profit).
Simple investment checklist:
- Check the balance sheet to see if the book value has been growing over the years.
- Check the balance sheet to see if the company has a reasonable debt-to-equity ratio.
- Check the income statement for years of consistent profitability.
- Using the income statement and balance sheet, check the history of the company’s ROE to see if it’s been efficiently managed.
Cash flow statements include all the money that flows in and out of a company (similar to a bank statement).
Discrepancies between cash flow and income statements are often due to income reported that hasn’t been received (accounts receivable) or depreciation costs.
Free cash = net cash from operating expenses - capital expenditures.
The goal of investing, from Benjamin Graham‘s perspective, is to purchase a company below its net current asset value.
Net current asset value (NCAV) / shares outstanding = fundamental/intrinsic value of a company’s stock.
Net asset value (NAV) = Book value = Equity = Net worth of business.
NAV is only different from NCAV in that it includes non-current assets like accounts receivable.
The ideal price-to-book ratio is 0.8 or lower.
Multiply a company’s earnings per-share (EPS) by your ideal P/E ratio to get the desired entry price.
As a general rule of thumb, a company’s dividend yield should be at least 2% higher than the risk-free rate.
V = EPS x (8.5 + 2G) —> V = intrinsic value; EPS = earnings per share; 8.5 = stock P/E ratio with 0% growth rate; G = expected growth rate over the next 10 years (average growth rate over last 10 years).
The key to investing is saving regularly, being patient, buying what you know, avoiding excessive debt and leverage, seeking a margin of safety, compounding, and diversification.