How Warren Buffet Invests passive income ideas

How Warren Buffet Invests

Knowing how Warren Buffet invests is very enticing. I’m always amazed how many articles claim to know something about how Warren Buffet invests, and then goes right back to giving the same generic, cliché, ineffective investment advice that Warren criticizes.

How Warren Buffet Invests passive income ideas

The first thing you have to realize about Warren is that he is mindful that many people listen to his advice when he speaks. Knowing how Warren Buffet invests will help you in a lot of ways. And also knows that his huge following is largely comprised of people who aren’t going to have the time, work ethic, and emotional discipline to invest as he does with his own portfolio.  So when he’s giving advice for the average investor, he does give a lot of sound, yet unimpressive suggestions that allow people to grow a modest nest egg over time.  For example, he advocates dollar cost averaging into Exchange Traded Funds (ETFs) which have shown to have similar performance to mutual funds without the ridiculous fees.

Different Rules for Warren….

But Warren follows a different set of rules because he considers himself a different type of investor.  In fact, it was his mentor Ben Graham who drew this distinction.  He called the average investor a passive investor.  He considered this type of investor to be someone who was more motivated to focus their attention elsewhere.  Since they wouldn’t be devoting themselves understanding and monitoring their investments, it would be too dangerous for them to become savvy stock pickers.  He concluded that passive investors should spread out, buy and hold, and be content to receive mediocre returns.

But then Ben talked about another type of investors.  What he called the “Enterprising” Investor.  This was not a passive investor, nor was this an emotionally impulsive speculator.  As Graham would put it “Investing is most intelligent when done most businesslike.”  It would be the Enterprising Investor who would devote themselves to business like investing. This is how Warren Buffet invests.

Warren and many of his colleagues who came from what’s known as the Graham-Dodd school of investing followed this path.  Warren Buffet would later refer to this type of investing as looking at the playing field instead of the score board.  And it has resulted in his track record which has dwarfed Wall Street.

What does Warren look for?

The reason I love Warren is because he’s actually a very grounded investor.  Many people don’t realize that Warren has in fact managed superior returns by greatly reducing risk.  Not by making reckless plays.

Warren actually takes a very basic approach to investing that most investors just don’t seem to catch onto.  He tries to figure out what a business is actually worth, then waits until it’s on sale, and finally he pulls the trigger to load up an attractive investment.

Looking for a moat….

The thing Warren tries to find is a moat which protects the castle.  He also refers to it as a durable competitive advantage.  The moat should be so big that none of the competitors can cross it.  And since they can’t cross it, the company can command superior sales, profits, and growth compared to its competition.

For example, Coca-cola was one of Warren’s best acquisitions because it had a moat.  The moat was the businesses branding and secret recipe.  Competitors just couldn’t come up with a drink that had such notoriety.  This allowed Coca-Cola to get prime real estate on every retail store.  And it also allowed to the company to charge higher prices for superior profit margins compared to its competitors.

That’s why Warren goes right to the financial statement.  If a business can make superior profits, and continue to capture market share, then it will be reflected in the financial statement.  Warren looks for stocks that have increasing financials year after year.  More sales, more earnings, more equity, more cash, and little to no debt.  This is the first sign that he’s found a superior company.  It also allows him to calculate an actual numeric figure for the intrinsic value of the company.  As Warren would say “Price is what you pay, value is what you get.”

Of course, his due diligence wouldn’t just stop here.  He also had to research the market, industry, and the demand for the product. Warren always wants to find a company that not only has a current competitive advantage, but one that is likely to continue for a long time to come.

Watch out for “idiot” management….

Warren is famous for his quote “I try to buy stock in businesses that are so wonderful that an idiot can run them.  Because sooner or later one will.”  But in reality, Warren cared very much about management.  A quality, business oriented CEO could make a great business even greater.  And a poor one could cause a lot of problems.

Warren always put the moat first, but we can often get a glimpse of what he looked for in management based on his own example.  For example, Warren doesn’t pay himself more than $100,000.00 year because he believes that an increase in the value of his shares should be his compensation. It creates and alignment of interest where he only prospers if the overall company does.  Compare that to Jaimie Dimon whose current compensation exceeds $28 million.

The best CEOs are often the founders of their company.  They put the needs of the company first, and strive after lofty goals more important to them than just making lots of money.  Warren also looks for CEOs who can admit to their mistakes, as he himself is frequently sited doing.

Margin of Safety….

Once Warren finds a strong, growing company with a durable competitive advantage, and a true leader at the helm, he not figures out what the value of the stock is.  Warren is a big picture kind of investor which is why when Wall Street analysts are obsessing over quarterly earnings, Warren is looking at financials as far as 10 years back.  He wants to know how much the company is likely to be worth over the next 10 years as that will give him the answer as to what price he’s willing to pay right now.

That’s pretty much how it works. It is worth knowing how Warren Buffet invests. The money is made in the due diligence just like with most any other type of investment.

Are you looking to shift from mediocre returns, to those of an “Enterprising Investor?”  Follow along as we share our approach.

 

 

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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