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The Warren Buffet Philosophy

Aug 17, 2007
In addition to being one of the world's wealthiest men, Warren Buffet is also known for his common sense investment advice. Instead of chasing hot stocks and market trends, the straight-shooting septuagenarian preaches simple and logical investment strategies that even the least financially inclined investors can follow. While there are as many stock-picking strategies as there are stocks to pick, Buffet's long-run returns serve as compelling testimony to the effectiveness of his methods.

While numerous books have been written about Buffet's investment advice, the primary focus of his philosophy is to look for companies with strong intrinsic value. Rather than relying solely on balance sheets or assumptions of value, he encourages investors to reflect on the nature of the company and its future. Who are their competitors? Is it a business with a high degree of customer loyalty? What are the barriers to entry? Are there any major logistical flaws in the company's business plan? By following Buffet's advice, an individual would have fared well through the technology bubble of the 1990s. The acceptable downside to this investment strategy is that the investor would also have missed out on many profitable opportunities that existed before tech stocks began to plummet.

In keeping with his common sense investment advice, Buffet emphasizes that an investor should invest in companies that he or she understands. He reasons that investing in the latest technology-oriented hot stock may lead an investor away from the use of common sense valuation techniques, causing the investor to make decisions based on hype rather than logic. Along those lines, he has been quoted advising individuals to invest in the companies where they spend their own money. Since doing business with a company is one of the best ways to see how it operates, it stands to reason that it would offer insight about the company's value as an investment. Instead of selecting companies that "everyone" is talking about, he argues that you should buy shares of the companies that everyone you know is doing business with, especially if price and market interest levels don't seem to reflect the quality you know is there.

While Buffet offers excellent non-technical investment advice, he also offers tips for those who know their way around a balance sheet. Instead of looking for companies that pay large dividends on a regular basis, he advises investors to seek out companies with a pattern of stable growth and reinvestment. His own company, Berkshire Hathaway, has only paid a dividend to shareholders on one occasion. At that time, he announced that he simply could not find a better use of the funds. Buffet also stresses that it is important to seek out companies with low debt-to-equity ratios and maintenance costs. A company with minimal debt obligations puts itself in a better position to weather temporary economic downturns.

Although most of Buffet's investment advice focuses on the actual company in question, timing is also an important component of his strategy. Rather than dumping a company when everyone else is dumping it, he prefers to pillage through the scraps to determine if the downturn provides a good investment opportunity. In fact, this very strategy helped him earn millions on American Express after he invested during a fraud scandal. Because market trends are often based on incomplete information, there is a tendency of investors to overreact. That overreaction is a big part of what Buffet's investment strategy counts on.

Despite the fierce proponents of hot stocks and market trends, very few investment strategies are able to stand the test of time. Warren Buffet's common sense investment advice has done exactly that, allowing him and many others to enjoy above average returns in occasionally dreary financial markets.
About the Author
Joel Arberman is the Managing Member of Stock Aware, LLC. We publish a free investment research and analysis newsletter. Learn more at
www.StockAware.com
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