Berkshire Hathaway speaks best about his investment achievements. Many investors would bet on knowing how to invest in the stock market like Warren Buffett. He took over Berkshire Hathaway in the year 1965. An investor who would have invested their dollars then would have seen it grow by more than 300 times by the year 2005 (45 years). Absolute returns of three hundred (300) times comes to 13.5% CAGR. If you compare this with S&P 500, your dollar would have grown only 50 times in last 45 years. It will be exceptional to know how to invest in the stock market like Warren Buffett and harnessing above average returns year after year. There is little doubt that his philosophies of investment are proven and if followed to its core will fetch great returns.
What is Buffett’s Philosophy by the way?
If one wants to learn how to invest in stock market like Warren Byffetts, than they must understand his philosophy of Investing, and it is based on the concept of Value Investing developed by his mentor and guide Benjamin Graham. The concept of value investing is simple, buy those stocks which are available at a hugely discounted rates below their intrinsic value. The trick of Buffets Investing lies in these two words – Intrinsic Value. If one knows how to calculate the Intrinsic value of stocks thenthey can claim that they already know how to invest in the stock market like Warren Buffett. What makes Buffett different form other investors is that he seems to know the intrinsic value of all good companies. And as there is no standard way or procedure to calculate intrinsic value of stocks, this decision by common investors is made more judgmental than on basis of facts. Warren Buffett first collects facts and news about the company, converts these information’s into its intrinsic value and then he knows how to invest in the stock market like a champion.
Warren Buffett selects his stocks on basis of the present fundamental values of the company; calculation of intrinsic value is done later. His decision on how to invest in the stock market like a champion is based equally on his know-how of ‘present fundamental values’ and on its ‘intrinsic value’. How knows how to invest in the stock market because before investing he makes sure that the companies has enough traits to make money for him in long term. Of course intrinsic value if one of the tools of Warren Buffett but his selection of stocks on basis of specific fundamental values are worth noting.
Let us look at how to invest in the stock market like a champion investor Warren Buffett
If one wants to know how to invest in the stock market like Warren Buffett he will have to ask himself the following questions which will ultimately will lead him/her to make money.
(1) What is the performance (ROE) of company in the past?
When it comes to performance he sees return on equity (ROE). Return on Equity shows how its share holders had made money on their investments in the past. Not only Buffett looks at the ROE of the company in considerations but he also compares it with the its competitors and try to make a judgment on expected returns of future.
Return on Equity (ROE) can be calculated by looking at Balance Sheet and Profit and loss accounts. Form Balance sheet pick a value called ‘Shareholders Equity’ and form Profit & Loss accounts note the ‘Net Income (PAT)’ made by the company in that financial year.
ROE = PAT / Shareholder’s Equity
Warren Buffett plots the ROE percentage for the last 10 years of a company and plots it to a graphical representation to see a growing-trend or a losing-trend. Unless investors learn to read the financial statements of the company they will find it hard to know how to invest in the stock market like Warren Buffett.
(2) Is company managing to keep its debt (Debt Equity Ratio) to minimum?
Logic of Buffett is very simple; he wants the companies to be more dependent on shareholders equity to generate income and least on borrowed money. His calculation of debt equity ratio is slightly different than normal understanding:
Debt Equity Ratio = Total Liabilities / Shareholder’s Equity
‘Total Liabilities’ & ‘Shareholder’s Equity’ of a company can be obtained form companies Balance Sheet.
In order to know how to invest in the stock market like Buffett, it will not be bad for investors to start obtaining the figure of Debt Equity Ratio and comparing with industry standards. This will give a good idea of how the company is managing its debts. It will also be better to compare the debt equity ratio of the company with the competitors. Warren Buffett never believes on one year figures. He would like to keep a record of minimum five to ten years.
(3) How the Profit Margins have grown in the past?
According to Warren Buffett, it not only sufficient to make profits in business but inorder to outclass the competitors one needs to keep on increasing their profit margins.
Profit Margin = PAT / Net Sales.
Investors shall calculate the profit margins figures of last five to ten years of the company, plot on a graph and see the pattern of growth or decline. Even plateaus will say whether the management is becoming complacent.
(4) How long the company been in public?
Ironically Buffett has not invested in technology stocks till date. He has made it a rule to invest only in established companies who has been in stock market since minimum ten years. All technological stocks are comparatively a new comers by his standards. But that’s not all with Buffett, he invests in companies only when he understands their ‘business’. He has been very frank in accepting the fact that till date he has not been able to comprehend the business process of most of the technological stocks.
(5) Are the company products unique or like a commodity?
Commodity stocks are not Warren Buffett’s picks. According to Buffett, companies which does not have a unique product is not worth investing in. These companies may make money in a short term horizon but its never far for a competitor to duplicate their product and emerge as a competition. Immense competition makes the business less profitable, which means lower incomes in long run.
(6) Is the company’s market price of stock is presently at 2/3rd of its Intrinsic Value?
This is final step of Buffett’s logic of buying stocks. One may do a small research and find companies which gives positive answers for the above five questions. But answering the question on intrinsic value is not easy. In order to give you a sample of how possible Warren Buffett may be calculating intrinsic value, I have done some on my own and would like to share with my readers. As a rule of thumb, Warren Buffett buy’s stocks whose present market price is approximately 2/3rd of its intrinsic value. In order to make out how to invest in the stock market like warren Buffett one must learn to calculate the intrinsic value of stocks.
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