5 Main Principles for Investing Like Warren Buffett

Warren Buffett has won the title of "world's greatest investor" thanks to his investment values. Buffett himself laughs at the moniker, but it's hard to argue with a net worth of $36 billion. However, this is not the case.

Warren Buffett did not become a billionaire by investing, and he would not “invest” in the way that the mass media portrays it. That may seem like a bold statement, but once you understand his methods for accumulating money, you'll be able to start managing your investments in the same way.

Warren Buffett's Untold Version

Buffett is a business owner, not an investor. An instructor who puts $100 a month into a mutual fund or a salesman who instead of going on holiday spends his $2,500 bonus on Apple stock is an investor. An investor is an accountant who has 5% of her salary deducted from her salary to put into her company's 401k program.

Buffett does not operate in this format. Warren Buffett buys enough stock to be appointed to company boards of directors. Even though he wasn't yet a millionaire, his investment partnership invested in a business named Sanborn Map Company, where he was appointed to the board of directors. When you serve on a company's board of directors, you have the power to influence the company's course as well as the hiring and firing of CEOs and CFOs. But this isn't anything you or I can do. Investing $100, $200, or even $1,000 at a time would not get you on the board of a publicly-traded corporation.

This is important for a couple of reasons. First, it detracts from the radiance and allure of Buffett's work. He doesn't just go out and buy an undervalued business and then sit in Omaha counting his money. Yes, he is picky with the businesses he purchases. Early in his career, however, he got into the trenches, so to speak, and was actively involved in the operations of many of the companies in which he invested.

Second, it stresses the importance of becoming an owner if you want to be wealthy. You can save and save a little over time, and if the market does not collapse as it did in 1987, late 2000, or 2008, you might end up with a couple of million dollars by the time you reach 65. If you need money faster, however, owning or being involved in the ownership of a company is the best option.

Is Warren Buffett a “Buy and Hold” investor?

The media and financial advisors use Warren Buffett as an example of why you should buy and hold. However, the representation isn't entirely true. When you buy and hold a stock, you buy and hold it regardless of the circumstances. It makes no difference whether there is good news or bad news, whether the president is a Democrat or a Republican, whether there is a recession or an economic boom. You keep the stock through good and poor times.

Buffett, on the other hand, buys for a particular reason and then sells when the reason no longer exists. Buffett, who is known as a value investor because he buys stocks with a low price-to-earnings ratio, looks for decent prices, sound management, and competitive advantage. In a 1996 letter to shareholders, he listed GM, Sears, and IBM as great businesses that couldn't remain competitive in their markets and therefore would have been dumped from a portfolio.

The Sage of Omaha should not buy stocks and keep them indefinitely. Berkshire Hathaway is the only one of Buffett's first 20 investments that he still owns, and it's probably just for the name. He no longer owns the other 19 properties. Despite this, there are journalists, financial advisors, business news anchors, and self-proclaimed investment educators who advise you to do so. But why should you do it if the world's wealthiest "investor" doesn't?

Warren Buffett's Investing Methods

Though you won't have an equity stake in the businesses you invest in, you can use Buffett's strategy to increase profits and decrease losses. The steps are simple and easy to understand, but they may be difficult to put into practice:

1. Make a list of the criteria you'll use to decide whether or not to buy a stock. You might, for example, search for stocks in a particular sector with a certain price-to-earnings ratio or a six-month moving average. Only keep in mind the stock price should not be the only factor to consider. A good company's price could drop due to market or sector fluctuations, which may present a good buying opportunity if the conditions you set are met.
2. Invest in industries and companies that you are familiar with. It would be easier to keep updated on business trends and company news if you know more about the markets or companies in which you invest. A long-term investing plan focused on hype or following other people's market recommendations is doomed to fail. If you're interested in a business you've never heard of but have heard a lot about, do some homework first.
3. If at all possible, keep your cash on hand. If none of the companies on your list meet your investment requirements, keep your money in the bank. The term "cash" refers to a financial position.
4. Follow the Businesses. If you've invested, keep track of the companies every month. Do not look at them regularly.
5. When it's the right time to sell, it's the best time to sell. Trade a company's stock when it no longer meets the criteria for purchase. If it falls below its two-year average stock price, you sell. Most Buffett devotees are unaware of this. He has a set of laws that he conforms to. He sells businesses that no longer meet his standards. If you want to remain in the investment, resist the temptation to make excuses. It would need to be sold. 

Putting Value Investing to Work

You could have purchased Apple for $32 per share at the end of 2004. You may have made this purchase because you saw the iPhone and iTunes craze, and these items were dominating the market. The economy was down at the end of 2008, and Apple's stock was down as well, dropping from $172 to $97 per share. The reasons to buy Apple, on the other hand, had not changed, so it would have been prudent to hold on to your shares and even buy more.

Apple's stock is currently trading at $680 per share. Compare that to Yahoo! It used to rule the search engine world until a small company named Google emerged. Yahoo! is now unable to compete, having lost market share that it will never regain. If you purchased Yahoo! because it dominated the Internet search room, the time to sell is long past. So, why would you want to buy it and keep it? Warren Buffett, on the other hand, does not.

Final Thoughts

Warren Buffett is unconcerned about stock markets daily, and he is unconcerned about what the press has to say. Furthermore, he is unconcerned about emerging technologies. He needs to know if he comprehends the industry. Is it underappreciated? Is it profitable? Buffett buys whether the answers to those questions are affirmative. If any of that shifts in five years, he sells. It's that easy.

This is how Warren Buffett invests like a pro. This is not a clear criterion for him, but it does demonstrate his commitment to following his investment rules and principles. His standards may or may not be the same as yours, or you may be a more technical investor who relies on math and stock charts. You will not become a billionaire regardless of the criterion you use, but you may have fewer losses in some investments and more income in others.