Stock Investing Advices #1: Simple Business Model
It is not just about simplicity, but also something that you can understand. You must clearly define your circle of competence and stay where you are. It can be something that you learn while you are working or something that you spend time on to understand the business operation. To most, oil and gas business can be seen as so simple and yet very profitable, but to those who works in that industry will tell you, it is not as easy as what you think.
Do you know why this is so important?
When come to investing, predicting what will happen tomorrow is something that you can’t live without. Forecasting what the future will be is the only way you can estimate how much return you’ll be getting later on. So, if you really understand the business inside out, you can project how the company perform 30 years down the road; take into consideration the national economy, competition from others and change in customers’ lifestyle.
Stock Investing Advices #2: Wide Economic MoatSimply said, the company should serve valuable niche market with price inelastic products or services. Warren Buffet himself avoids regulated industries, commodity businesses as well as capital intensive industries.
He prefers stocks which can finance their capital from operating cash flow with less borrowing as well as has strong pricing power. Meaning, the company can price their products as much as they want. That is why, Warren Buffet love ‘franchise’, for example, Furniture Mart (the lowest cost in the industry), The Washington Post (market dominance and leader), Coke (strong brand name) and Candies (premium priced and high quality products that serve niche market).
Stock Investing Advices #3: Sustainable Growth
Serving the existing niche market is not enough. Instead, Warren Buffet wants the company to grow continuously and exponentially. Therefore, he looks for managements that have the ability to widen their economic moat consistently over the past years. Their businesses must be positioned where the demand able to grow continuously; Gillette is his best example. In the same time, always be ready for any possible trouble to the business, and most importantly back up your investment plan!
Stock Investing Advices #4: Excellent Capital Management
Every company that is listed in the stock market were entrusted to manage the business on behalf of their shareholders. Therefore, it is the managements’ duty to utilise the available resources for the highest possible return. To do this, they have to think and act like an owner and avoid the ‘institutional imperative’ style of management (think for themselves and don’t care what will happen 20 years down the road). When they don’t have the capability to create at least $1 value from $1 reinvestment, they should return the capital back to the shareholders by giving dividends or share buybacks.
Stock Investing Advices #5: Effective Management Team
Invest in company that have honest and capable managers. They should be so capable that Warren Buffet himself admires the way the managers do things. In Berkshire Hathaway Annual Meeting year 2000, he once said, “we want managers who tell the truth and tell themselves the truth, which is more important”. He loves cost conscious and frugal type of managers who are honest and integrity as well.
Stock Investing Advices #6: Superior ROE
Why ROE, and not the other financial ratios? Well, return on equity indicates how effective the management team convert the reinvested money into cash. The higher the return, the more profitably the company can reinvest its earnings. The faster the company able to turn the reinvested earnings into profits, the faster its value increases from one year to another. And mind you, it is a big challenge to the management to consistently create value for every penny they spend. To prove this, not many stocks that has 15 per cent ROE consistently for the past 20 or 30 years, worldwide.
Stock Investing Advices #7: Buy at Discount Price
Once the good stocks have been identified, now is the time to buy them. To make sure every $1 investment will generate $2000 in just 30 years, Warren Buffet have to make sure he buys the stock at the lowest price possible. In the same time, he has to be real that not to set very low price till he misses the golden opportunity. Thus, he keeps himself buying the stocks when the prices are offered at pre-determined margin of safety. The margin of safety can be as low as 80 per cent discount from the calculated intrinsic value. Even if the stocks are so profitable but the price is too high, he will just passes the opportunity to somebody else.