The conventional view is that most people cannot beat the market in the matter of investing. Therefore the usual advice is to buy index funds or index ETFs. However this is a belief and you have to see whether you want to believe this or not. This does not mean that there is some secret trading system which will make you rich. Warren Buffet followed an investment method and stuck to it through thick and thin. That is why he made a lot of money. The key principles of that investment method are as follows:
1. Investment Rule Number 1: Never Lose Money
Investment Rule Number 2: Never Forget Rule Number 1.
2. Risk comes from ignorance.
3. Buy businesses with good and exceptional economics and buy them at a sensible price. Repeat until rich.
4. The stock market is the only place where people who drive BMWs take advice from people who take the train.
5. If you need complicated maths for investing, I will probably be distributing newspapers today.
6. Understand the power of compounding.
7. Don’t lose an ounce of reputation and integrity, not one single ounce. You can always make money back, but once you lose trust, it will take a longer time and effort to earn back the money.
8. Stocks are businesses.
9. Traditional value investing involves buying a business when the share price is below the book value per share. Buffet type value investing is buying businesses with good to superb underlying economics at a sensible price.
10. The key is to only and always buy businesses with a durable competitive advantage.
11. Bet only when the odds are in your favour. How you do anything is how you do everything. Therefore be disciplined about this in all aspects of your life.
12. There are five questions to ask when analysing whether a business has a competitive advantage:
- What value(products/services) does this business provide?
- Is this value provided by anyone else?
- Will I choose to get this value from elsewhere instead of this business?
- Why would we rather get this value from this business instead of from anywhere else?
- Is the reason we have identified in the above question sustainable in the long run?
13. Buy businesses within your circle of competence. Ask yourself: What do I have to spend money on every months? Where do I love to spend money on? Where do I earn my money from?
14. Ask yourself if the business’s model of profit is sustainable in the long run, using STEP analysis:
- S= Sociocultural: Will customers continue to want goods and services from this business?
- T= Technological: Will rapidly improving technology, particularly the internet, aid or threaten this business?
- E= Economy: Will this business be affected by poor economy?
- P=Political factors: Will government regulations be neutral or supportive of this business, and not negative?
15. Is it a business that provides value to other businesses and not individuals?
16. There are five ways for a company to build a competitive business:
- Product differentiation
- Low costs/ Low-Price Producer
- High switching costs
- Legal barriers to entry
17. The track record of a business is the proof that it is a superb business.
18. The business should have steady and consistent profits rising over the last ten years.
19. The only time to buy IPOs is on a day with 25 hours.
20. The company should have a consistent average return of equity of 15%. The return on assets must be at least more than 7% on a consistent basis. This is to make sure the company is not taking too much debt.
21. Our greatest asset is ourselves, so continuously take care and invest in ourselves.
22. Debt/equity ratio should be less than 0.5. Long term debt should be less than 5 times net income. Interest coverage ratio( no of years of interest expenses that the company can pay with an year’s profits) should be atleast 3.
23. Make sure the operating cash flow is consistently positive. The free cash flow should also be consistently positive.
24. If you can raise prices without losing business to a competitor, you have a very good business. And if you have to have a prayer session before raising prices by 10%, then you have a terrible business. Make sure a business has pricing power.
25. Buy businesses that even a fool can run, because someday one will.
26. Price is what you pay. Value is what you get. Buy businesses with the notion that the stock market will not reopen for the next five years. In the short run, the market is a voting machine but in the long run, it is a weighing machine. Mr. Market is a good partner, but a lousy advisor, he is here to serve us, not instruct us. Look at what has happened to the price and earnings over the last 5-10 years.
27. To find a target buying price do the following:
- Find EPS annual compounded rate over the last 10 years.
- Estimate EPS 10 years from now
- Estimate stock price 10 years from now
- Determine target buying price today based on desired returns
- Add margin of safety.
28. Our favourite holding period is ever. Sell if
- Price rises and hits or overshoots desired returns.
- When there are better opportunities
- When a great business loses its competitive advantage due to changes in the business environment
29. My idea of a group decision is to look into the mirror. You have to make your own decisions.
30. Be wary of people who are good in one area of life who tell everyone how live their lives. learn from experience, but also learn from other people’s experience when you can. Do not confuse rich with being successful. Be a good person who is rich. Money is not the ultimate goal. It can’t change how much people love you or how healthy you are. Success is being loved by the people you love. The only to be loved is to be loveable. Do the things you love and love the people you love and love them today.
– notes from the book Gone Fishing with Buffet by Sean Seah