The Warren Buffett Way To Invest

Even though you have all heard this a million times, and it has been proven over and over, many of you will not heed this advice and will lose a lot of money in the long run for a shot at the big bucks.

Note that I said investing, and that the title of this article is “The Best Investment Advice” not “The Best Trading Advice.” If you don’t know the difference between the two, you’d do well to research it.

Warren Buffett, Benjamin Graham, Bill Miller, and Peter Lynch are arguably the best investors of all time. I have researched their methodologies extensively. When you combine the best methodologies of the best investors, you will come up with the best investing strategies. I will list a few of them below.

These should be the foundation for EVERY single investor who wishes to reduce risk and maximize return.

Company Economics

Understand how the company makes money. If you can’t verbally explain to someone how they make money, you certainly shouldn’t own stock in that company.

Long-Term View

If you understand how the company works, and you wish to purchase stock in it, imagine this scenario: As soon as you purchase the stock, the stock market closes for 5 years. This means that you will not be able to sell the stock for 5 years. If you are still comfortable with the purchase, then it is a good investment. If not, don’t buy it.

Insider Ownership

It is always a good thing when management owns a significant portion of the company’s outstanding shares. This doesn’t mean that a company whose management does not own a significant portion of the outstanding shares is a bad choice, though.

Return on Equity

The company should get a return on equity of over 15%. This is a Warren Buffett staple. A company that cannot generate 15% returns on their equity is not a very good company. There are exceptions to this, however. Growth companies who are still trying to make it off the ground generally don’t have this high ROE and oftentimes they have negative ROE. Successful investing in growth companies is not impossible, but it requires a bit more luck.

Blood in the Streets

If a company has been beaten down for a reason that is NOT related to their performance, such as analyst downgrades, a buy opportunity is created. Warren Buffett has a famous quote that goes: “Buy when there is blood in the streets.” Learn it, live it.

Buy Low, Sell Never

It is a fact that the stock price of a company fluctuates up and down faster than the actual performance of the company. This means that the VAST majority of stocks at their 52-week high are actually overvalued. This also means that the VAST majority of stocks below their 52-week low are very undervalued. All the best investors would rather buy stock in a company near its 52-week low than near its 52-week high.

Cash is King

Choose stocks with high cash and little debt. Hard times aren’t quite so hard when you have lots of cash on hand.

The Rest

If you are a growth investor, Peter Lynch suggests that you buy stocks with a P/E ratio less than the estimated growth rate. This results in a PEG of less than 1. Of course this uses analyst estimates, so it’s never a sure thing.

It is also important to note that the average investor should not invest in stocks that Warren Buffett, Peter Lynch, and Bill Miller invest in. Even though they are some of the worlds greatest investors, the investments they choose are not optimal for you, they are optimal for them.

How can something be optimal for one investor and not for the other? Aren’t we all in it just to make money? The answer to that question is yes, we are all in it to make money. But there is a huge difference between you and Warren Buffett. He has billions of dollars to invest. If he invests 1 million in a small company and earns 10 times his investment, his total portfolio moves up about .001%. For you and I, the average investor, that would be 1000% gain, assuming we only had 1 million invested overall. Thus, poor Warren and company cannot invest in small companies. They literally have to invest in large companies that historically offer lower returns.

Warren himself said that if he didn’t have as much money as he does, he could make 50% per year. That means that you, the average investor, can easily make more than Warren Buffett, the worlds greatest investor, can make (in terms of % gain). Along these same lines, it is also important to note that the companies which Warren and company must invest in are large, well followed (especially after he buys) companies. This puts them in the spotlight and raises the demand for stock in the company. Always true to form, the law of supply and demand forces the price up when the demand goes up and supply remains the same (for arguments sake, the supply would actually be less now that Warren bought a significant amount, which he has no choice but doing).

It is my suggestion that investors use a blend of value and growth in their investment decisions and never to invest in companies that are in the spotlight.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.