No investor has been more lionized and admired than Warren Buffet, and with good reason. His long-standing success is unparalleled in the field of finance. Over a period of years from 1965 to 2017, his company Berkshire Hathaway has produced a more than 20% annual return. For comparison purposes, during that same
But how has the so-called Oracle of Omaha done this? The answer lies in 3 important strategies that he uses.
1. A Circle of Competence
Buffet coined the phrase “circle of competence” during Berkshire Hathaway’s 1999 annual meeting. What it means is that investors must thoroughly understand the business that they are investing in. More to the point, Buffet believes that if investors want to avoid making big mistakes, they should look to invest in companies that operate in industries in which they have expertise in.
Buffet thinks that this is important because you need to know how a company makes its money. You also need to be confident that this company can continue to make money well in the future. He calls the latter concept “judging the future economics of a business.”
Buffet further insists that if someone is not certain that a business operates in their circle of competence, it probably means that that business is not operating in it.
2. A Piece of a Business
No one is born a great investor, not even Warren Buffet. As a teenager, he tried his hand at investing and failed at it. He continued falling at it even after he read many books on the subject.
So, what changed?
At Berkshire Hathaway’s 2002 annual meeting, Buffet talked about how one book he read in 1949 changed his life. The book was called “The Intelligent Investor,” by Ben Graham. The book stated that, when you are buying a business, you are not buying stocks charts or earnings news. Instead, you are buying a piece of a real business.
What this means is that, when buying stocks, you should not become fixated upon the movement of prices or some short term news that could affect these prices in the same short term. He said that you should understand that you are buying a small slice of an actual business.
3. A Margin of Safety
At Berkshire Hathaway’s 1996 annual meeting, Buffet described what he called a “margin of safety.” He said that if you are driving a truck that weighs 9,800 pounds, you should never drive it over a bridge whose capacity is only 10,000 pounds. Instead, you should look for a bridge that has a capacity of 15,000 pounds.
What this means in terms of investing is that, when looking for a company to invest in, you should look for one whose price is much lower than what you value it. The margin of safety is the difference between the two, and having a sufficient amount of it can limit your investment risk in case you have made incorrect assumptions about the company.
In essence, it means that you should pay far less than the value you are getting.