3 tips to pick stocks like Warren Buffett
Warren Buffett is considered to be the world's greatest investor, an accolade he has earned with over six decades of successful stock picking. The Oracle of Omaha has turned a $100,000 investment into one of the world's largest companies over his career. At the same time, Buffett has educated and inspired tens of thousands of other investors.
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His stock picking acumen is second to none, mainly due to the amount of time he's been practicing his art. Such experience only comes with time, but there are a few stock picking tips we can learn from him to help us improve our own investing strategy.
Don't lose money
Warren Buffett's first two rules are:
Don't lose money
Don't forget rule number one.
These two points are critical for investors but are also frequently misunderstood. What Buffett is trying to say is investors should avoid high-risk opportunities where the chance of permanent capital impairment is high. Instead, investors should favour equities that are likely to produce slow and steady returns and are unlikely to lead to hefty losses.
If you invest in a stock where you end up losing everything, it can be difficult to recover your position afterwards. What's more, the psychological impact of such a loss may lead you to make other decisions that might not be best for your wealth.
Pricing power
The best companies in the world and the best investments are those that can set their own prices. Warren Buffett's favourite, Coca-Cola, is a great example. Consumers love the brand and are willing to pay more for the product because, while there are strong alternatives, Coke's formulation, image and marketing turns ordinary consumers into diehard fans who wouldn't consider those alternatives.
The same can be said for products by the likes of Apple and Philip Morris. If a firm has pricing power, it is not subject to cyclical market swings. The company can raise prices and maintain margins in all economic environments, producing the best returns for investors along the way.
Cyclical businesses such as miners and oil companies are price takers and are therefore subject to market movements outside of their control. As we have seen over the past three or four years, such a lack of pricing power can be hugely damaging for the long-term fortunes of these companies.
Management is key
A third tip to help you pick stocks like Buffett does is to pay close attention to management. A firm's management has always factored heavily into Buffett's investment decisions because without a trustworthy team of managers at the helm you cannot trust that the business will be led in the right direction.
The number of shares manages own in relation to annual salaries as well as their experience and length of stay at the company are great ways to assess management skill. If management lies or misleads shareholders, this is one big red flag to investors that they cannot be trusted.
Avoid these fundamental mistakes
Warren Buffett has made billions trading stocks, and every investor can learn an enormous amount from the chairman of Berkshire Hathaway, especially when it comes to avoiding investment mistakes.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool UK has recommended Coca-Cola. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
