In 2018, business news leader CNBC examined decades of public comments by Berkshire Hathaway's hugely successful CEO Warren Buffett to learn what's behind his remarkable investing accomplishments. It came up with his three core recommendations for buying stocks.
These are:
- Invest within your circle of competence.
- Think like abusiness owner when buying equities.
- Buy at inexpensive prices to provide a margin of safety.
CNBC noted that from 1965 through 2017, shares of Buffett's Berkshire Hathaway Inc. (BRK-A) delivered a compounded average annual return of 20.9%, more than double the 9.9% return for the .
The upshot was that the cumulative gain for Berkshire Hathaway stock was 155 times greater than that for the S&P 500 over that period.
Read on for more on Buffett's three best investing rules.
Key Takeaways
- Warren Buffett's public comments can offer valuable investment insight.
- Three key Buffett rules for buying stocks have helped propel Berkshire Hathaway's returns.
- Buffett's circle of competence rule relates to buying stocks in companies that you understand.
- He believes that stock investors should be more concerned about a company's business than short-term stock price volatility.
- Buffett has long been a proponent of value investing.
1. Circle of Competence
Buffett believes that investors should avoid going too far afield from their expertise when buying stocks.
Instead, before they buy, investors should make sure that they fullyunderstand how a business operates, how itmakes money, and the future sustainabilityof its business model and profits. He referred to this as "operating within what I call your circle of competence" during the 1999 Berkshire annual meeting.
With the notable exception of smartphone and personal computer makerApple Inc., Buffett passed up on a number of winning investments in the technology field precisely because he did not feel sufficiently competentto judge their business models.
Berkshire Hathaway increased its stake in Apple over time. In June 2023, it owned 5.8% of Apple's outstanding shares. Apple stock made up 50% of its stock portfolio.
2. You're Buying a Business
A second key insight that Buffett gained as a college student in 1949 came from reading The Intelligent Investor, the seminal bookbyvalue investingpioneer Benjamin Graham.
As Buffett said during the 2002 Berkshire Hathaway annual meeting, "You're not looking at things that wiggle up and down on charts, or that people send you little missives on, you know, saying buy this because it's going up next week, or it's going to split, or the dividend's going to get increased, or whatever, but instead you're buying a business."
Thekey tenet of Graham's book is that buying stock makes youa part owner ofa business. As such, youshould not be concernedaboutshort-term fluctuations in stock prices.
Indeed, Buffett believes that such price movement, typicallyreferred to as volatility, represent temporary "noise" that should be ignored by long-term investors.
3. Margin of Safety
A third rule that Buffett learned from Graham is to buy stocks with a large margin of safety. That is, investments that sell significantly belowtheir intrinsic value.
This bargain-hunting approach to investing should limit your potential losses in case your estimate of intrinsic value was too high, or if unforeseen events damage a company's once-rosy prospects.
Coming up with an accurate estimate of intrinsic value is not easy. But the Graham method, as employed by Buffett, rests on rigorous fundamental analysisof the data pertinent to a company, its industry, and the general economy.
Buffett stands out among investors in his decades-long ability to make astute judgments of value.
From 1964 to 2022, Berkshire Hathaway's overall return was 3,787,464%. The return for the S&P 500, including reinvested dividends, was 24,708% for the same period.
Other Advice From Buffett
Never Look at a Headline
For the average investor who lacks Buffett's analytic prowess and sharp eye, casting their lot with the long-termprospects for the U.S. economy and the U.S. stock marketmay be the safest bet.
"The best single thing you could have done on March 11, 1942--when I bought my first stock--was buy a stockindex fundand never look at a headline...as if you had bought a farm."
Buffett noted that a theoretical $10,000 investment in an index fund back then would be worth more than $51 million in 2018, including reinvested dividends.
Make the Most of a Good Opportunity
This ties into a well-known saying of Buffett's. "Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble."
Take advantage of solid investment ideas whenever you can. And invest as much as you can because they won't always be available. Lower values and a drop in prices may not return.
Temperament, Not Intellect, Is Key
Keep a cool head when others around you are madly buying or selling. That's what makes and keeps investors successful.
It's vital to analyze and understand what's happening with a company and its business. Resist going with the herd or with popular mouthpieces who call for particular actions.
Remain objective and leave emotions out of your research and investment decision-making.
Read about Investopedia's 10 Rules of Investing by picking up a copy of our special issue print edition.
Buffett's Winners
With market values as of March 2023, the biggest winners in Berkshire Hathaway's stock portfolio since purchase are:
Coca-Cola (KO)
- Cost: $1.3 billion
- Market value: $24.8 billion
American Express (AXP)
- Cost: $1.3 billion
- Market value: $24.0 billion
Moody's (MCO)
- Cost: $248 million
- Market value: $7.5 billion
Apple (AAPL)
- Cost: $30 to $35 billion
- Market value: $151 billion
Buffett's Losers
To be sure, Buffett has chosen a number of losers. His worst performers year-to-datethrough November 2022 included:
Snowflake (SNOW)
- Change: -58.4%
- Unrealized loss (in millions): -$1,210
Nu Holdings (NU)
- Change: -55%
- Unrealized loss (in millions): -$553
RH (RH)
- Change: -48.7%
- Unrealized loss (in millions): -$616
Floor & Decor Holdings (FND)
- Change: -45.5%
- Unrealized loss (in millions): -$282
What Does Warren Buffet Look at When Choosing Stocks?
Among other things, he looks at company performance and for a reliable return on equity, the amount of debt a company has relative to equity, profit margins, the uniqueness of a company's products or services, and whether the company has a competitive advantage.
Does Buffett Own All of Berkshire Hathaway?
Warren Buffett owns 15.6% of Berkshire Hathaway and controls 31.5% of the voting interest. He is the largest shareholder.
How Old Was Warren Buffett When He Started Investing?
According to Buffett, he purchased his first stock when he was 11 years old, in March of 1942.
The Bottom Line
Through the years, Warren Buffett has been generous about sharing with the public his accumulated wisdom about investing. His enviable overall investment record confirms how valuable his key investing rules can be if adhered to over time.
The remarkable price of Berkshire Hathaway stock ($550,341 per share as of Sep. 22, 2023) reflects Buffett's investment success, as well as his contribution to the companies in Berkshire Hathaway's portfolio and tothe wealth of his long-time shareholders.
As someone deeply immersed in the world of finance and investment, I've closely studied the strategies and principles that have shaped the success of renowned investors like Warren Buffett. My extensive knowledge and expertise in this field enable me to dissect and elaborate on the key concepts presented in the provided article.
1. Circle of Competence: Warren Buffett's first rule advises investors to operate within their "circle of competence." This principle emphasizes the importance of investing in businesses that one thoroughly understands. This involves a comprehensive understanding of how a business operates, generates revenue, and sustains its profitability. Buffett's personal experiences, highlighted by his initial reluctance to invest in technology companies like Apple, underscore the significance of staying within one's area of expertise. The article further emphasizes that Berkshire Hathaway increased its stake in Apple, showcasing the application of this principle over time.
2. You're Buying a Business: The second key insight from Buffett is to view stock investments as ownership in a business rather than focusing on short-term stock price fluctuations. This idea, inspired by Benjamin Graham's seminal work "The Intelligent Investor," encourages investors to adopt a long-term perspective. Buffett dismisses short-term market noise as irrelevant to the fundamental value of a business. The article cites Buffett's belief that stock prices' volatility represents temporary "noise" for long-term investors.
3. Margin of Safety: Buffett's third rule, borrowed from Benjamin Graham, involves buying stocks with a significant margin of safety. This means investing in stocks that are priced significantly below their intrinsic value. The article underscores the challenge of accurately estimating intrinsic value but highlights Buffett's success in employing rigorous fundamental analysis. The aim is to limit potential losses in case of overestimation of intrinsic value or unforeseen events affecting a company's prospects.
Additional Advice from Buffett: The article also includes valuable advice beyond the three core principles:
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Never Look at a Headline: Buffett recommends a focus on the long-term prospects of the economy and the stock market, suggesting that investing in an index fund can be a prudent strategy.
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Make the Most of a Good Opportunity: Investors are advised to seize solid investment opportunities when they arise, as they may not always be available.
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Temperament, Not Intellect, Is Key: Keeping a calm and rational mindset during market fluctuations is crucial. Investors are urged to resist herd mentality and emotional decision-making.
Buffett's Winners and Losers: The article provides insights into the performance of Berkshire Hathaway's stock portfolio, showcasing successful investments in companies like Coca-Cola, American Express, and Apple, as well as mentioning some underperformers such as Snowflake, Nu Holdings, RH, and Floor & Decor Holdings.
What Buffett Looks at When Choosing Stocks: Buffett's criteria for selecting stocks include evaluating company performance, reliable return on equity, debt-to-equity ratio, profit margins, uniqueness of products or services, and competitive advantage.
Other Personal Details: The article also touches upon Buffett's ownership stake in Berkshire Hathaway, his age when he started investing (11 years old), and the significant impact he has had on the wealth of his long-time shareholders.
In summary, Warren Buffett's enduring success is attributed to these core principles, and his track record serves as a testament to the effectiveness of his approach to investing. As an enthusiast with a deep understanding of these principles, I can attest to their relevance and application in the dynamic world of financial markets.
