The Trader: What can traders learn from Warren Buffett?

Warren Buffet is one of the greatest investors of all time.

He has acquired wealth through relatively simple investing rules and sticking with them.

Investing is completely different to trading, but I’m always open to reading about others’ successes and learning from them.

In this article, we’re going to explore some of Warren Buffett’s secrets.

1. Warren Buffett buys businesses, not stocks

The first Warren Buffett does is buy businesses and not stocks.

Warren believes that a stock is something you can see on an Excel sheet with a lot of numbers and metrics.

This is helpful, for example, the income statement will tell you how profitable the company is.

The balance sheet will give a picture of the financial health of a company at a certain point in time.
But ultimately there are many things that you can’t see on financial statements and calculated through Excel metrics.

For example, a company called Cake Box listed in London has terrible Trust Pilot reviews. Granted, many customers only leave a review on Trust Pilot if they’ve had a negative experience. Nobody goes home and writes about their mediocre at best experience. It’s expected. And if the customer has an above-expected experience, they’re probably not going to write about it either because there’s nothing in it for them.

But looking at data that doesn’t appear on the spreadsheet can give you more factors to consider than just the crunched number.

If lots of people are saying the site is dirty and at various sites – maybe that’s a companywide problem.

2. Warren Buffett looks for economic moats

An economic moat protects the business from competitors. If a company has a moat, it can often have relatively high margins because there are no immediate predators out there to bring the gross margins down.

A good example of this is London-listed Safestyle. Safestyle installed UPVC windows and charged a lot of money for doing so.

There isn’t much of a moat in that business – competitors could just undercut them and all they’d have to do for that is to just sell and install some windows.

A good example for a company moat is a biotech company. If a company’s asset has gone through a phase III trial and it’s expected to be a blockbuster drug, it’s difficult for someone to instantly create their own drug because it takes years of research and millions of pounds. It’s a difficult business to displace.

A moat stops competitors replicating your product or offering.
In Safestyle’s case, the stock price collapsed. Competitors undercut them because Safestyle company had no moat.

3. Warren Buffett looks for intrinsic value and not short-term earnings

Another thing Warren Buffett looks for is intrinsic value and not short-term earnings.

A lot of people in the market are short-term. They may call themselves an investor but don’t think beyond a year.

Investors should be looking at multi-year timeframes and not looking at the share price. Long-term investors aren’t focused on short-term earnings matter because the company might miss on earnings
due to something beyond their control such as supply issues.

Sometimes there can be no problems with the business, but because the market is so short-term it might sell the stock off savagely.

Warren Buffett looks at the fair value of the stock and focuses on that, rather than looking at quarter after quarter.

4. Don’t follow the crowd

This is something I can agree with: you shouldn’t follow the crowd.

People are herd animals. The reality is if you go with the herd, you’re only going to get back average returns.

To beat the market, you need to do something different.

People buy stocks because their friends are in them and it feels comfortable.

Sometimes, all they are doing is buying into an overinflated piece of junk.

The actual trade there is to short the junk back to reality.

This is an advantage that private investors have because they have full discretion of their own money.

Now, sometimes the crowd is wise. But if you can give a valid reason as to why the crowd is wrong, you’ve probably just found a very good trade (and the first thing you should do when you find a trade like this is to tell me about it).

5. Invest in what you know

This echoes what Peter Lynch said about not investing in stocks that you can’t illustrate with crayons.

Know your circle of competence. If you’re a doctor and you know the medical industry well, you have an advantage here.

Mr Buffett didn’t buy into tech in 2000 so he missed the big speculative rally up, but he also missed the downward fall. He didn’t understand what he was buying so he left it out.

But here’s the part that others miss. He also says to keep learning and growing that circle of competence. Warren spends a lot of the day reading annual reports and newspapers to expand his knowledge. This gives him time and clarity to make such high-powered decisions.

This is why he makes such concentrated bets and holds high positions in stocks because he feels like he knows everything about a business and he’s got the risk covered.

Private investors have access now to be able to speak with management teams, watch presentations, ask questions and keep learning about different businesses and sectors. Don’t waste the opportunity lightly.

Michael Taylor

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Twitter: @shiftingshares