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What Made Warren Buffett a Billionaire?

by Arsalan Haroon 2 months ago in investing
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Warren Buffett’s Investment Strategy

Warren Buffett is currently worth 95.8 billion dollars as of 2022. Buffett is the most successful investor by any measure. He becomes a billionaire by investing in good businesses.

Buffett’s simple yet powerful investing rules made him an inspiration for many investors who want to be rich.

In investing, It’s better to follow strategies that already work for successful investors and use them. Buffett’s investment strategy has proven time and time again to be a very successful strategy that can make a lot of money for investors.

Warren’s investment strategy is simple to understand, But practicing his investment strategy is harder. That’s why most investors understand Buffett’s investment strategy. But it is hard for people to follow because it requires enormous work and patience.

Some investors who followed Warren Buffett’s investment strategy had made millions of dollars. So what is Buffett’s investment strategy that made him and others who follow him so rich?.

Investing in business with pricing power

In 1988, Warren Buffett invested 1 billion dollars in coca-cola. Today the investment is worth approximately 21.5 billion dollars, excluding dividends. It is one of the best investments that Buffett ever made.

One of the things that he looked for in coca-cola was if coca-cola decided to raise its soft drink price by 10 cents. Then most people will still drink coca cola because you cannot find the same taste in different soft drinks. Most people will be willing to pay a little bit more to drink coca cola because they can’t switch to another soft drink with the same taste as coca-cola.

So the point is that coca-cola can raise the price of their soft drink to increase their profit without losing their customers.

But on the other hand, if an oil company raises prices to increase its profit. Most people probably will switch to other oil companies that did not raise prices. So it usually loses its customers.

Most companies that sell commodities will usually not have the pricing power to raise prices to increase profit because customers can buy that commodity at a lower price through their competition.

Commodity companies sell the same product as their competitors. They have to compete with their competition with pricing. Providing customers with low prices than competitors is crucial for commodity businesses because it will increase demand for their commodity.

But Companies like coca-cola or apple can raise prices without losing customers because their customers cant find the same product from other companies.

Customers are loyal to companies like coca-cola because of their quality products which customers won’t find anywhere, and that is the business Buffett wants to invest in.

Buffett wants to invest in a business with pricing power because it usually has loyal customers, which can help the company grow its profit and increases its share price.

“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business. I’ve been in both, and I know the difference.”

— Warren Buffett

Buy a great company at a fair price than a fair company at a great price.

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

— Buffett Letter to shareholders for the year 1989

Buffett’s investing rules seem simple and easy to follow, yet few people practice them in the financial market. Most people in the stock market focus on buying fair companies at cheap stock prices.

In the early years of Buffett’s career, he would invest in fair companies that were selling very cheap relative to their earnings.

He would buy the company at a low price relative to earnings and sell the company when he thought that the market had realized the value of the company. But when he met with Charlie Munger, this would all change.

“There are huge advantages for an individual to get into a position where you make a few great investments and just sit on your ass: You are paying less to brokers. You are listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded.” — Worldly Wisdom by Charlie Munger 1995–1998

Charlie Munger advised warren that buying a company at a cheap price is not the most important thing.

Even if you buy the company at a slightly higher price than its current value, you can still make money when the business provides quality products and services to a much larger audience in the future.

You can’t tenfold your money by buying stocks at a low price relative to earnings because the difference between the value of the company and the stock price would not be much big.

So an investor consistently has to sell the stock when it reaches its real value and pockets some profit. Then find another stock selling at a cheap price and repeat the process.

Charlie Munger believes that investors would be better off buying a few good quality companies for the long term that tenfold their investment.

Charlie Munger and Philip Fisher were the two great investors that influenced buffet’s shift from buying a fair company at a great price to buying a great company at a fair price.

Today, Buffett doesn’t focus too much on companies that are not very good at what they do and are selling at cheap stock prices.

Instead, he may pay a little bit more for a great company that is good at what they do. These types of companies can be 10-fold his investment in the long term.

He doesn’t worry very much about how cheap the stock price is. Instead, he wants to know how good the company will do in the next 10 or 20 years.

Dont buy a poor business selling cheap relative to its earnings. You can’t tenfold your investment by doing this. Instead, you want to focus on investing in a few good companies that will be tenfold your investment in the long term.

Hold for the long term!

Warren Buffett has held coca-cola since 1988. Buffett has always invested in companies for the long term. He famously said that his holding period is forever.

Whenever Buffett wants to invest in something, he usually looks for companies that will grow in 10 or 20 years no matter what technology shifts happen.

If you invest for 10 or 20 years, Many Studies have also shown that the chances of making money in the stock market increase significantly.

Before holding any company in your portfolio, you should ask yourself if the company is a good holding position for the long term.

“[Our] favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. [American investor] Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.”

— Buffett Letter to shareholders for the year 1988

Margin of safety

The margin of safety means that you buy the company below its intrinsic value. The difference between the value and the price you paid is called the margin of safety.

Warren Buffett prefers to buy good business with a margin of safety because it gives him the certainty that the stock will go to its intrinsic value even if the company doesn’t grow. He at least doesn’t lose all his investment.

Warren Buffett learned the margin of safety concept from Benjamin Graham. He has had an enormous impact on Buffett’s investment strategy.

The margin of safety can give an advantage to investors and decrease your likelihood to lose a lot of money on an investment.

If you want to know more about the margin of safety, then I recommend reading the intelligent investor by benjamin Graham

Good management

Warren Buffett only buys a company with good management that is honest to its shareholders. Buffett wants management to be brutally honest with its investors about the company’s situation.

Buffet wants management that doesn’t spend money on unnecessary expenses that can hurt the profitably of the business.

Good management delivers on its promises. Good management accepts its mistake and tells investors what they did wrong.

If a business has good management, then you will feel comfortable that the people running the business will act in the interest of its shareholder, Which is to increase the company’s profitability and increase the stock price in the long term.

One way to check the management is to see if they are telling both the good and bad of the business or if they are just telling a few good things about the business and ignoring bad aspects of the company.

Check previous annual reports on what management had promised to deliver and go to the recent annual report to see if they had delivered on its promises or not.

Circle of competence

Warren Buffett is successful because he only invests in businesses that he understands. He usually doesn’t invest in high-tech companies except for Apple because he doesn’t understand them.

Buffett knows his circle of competence, and he stays in that circle of competence. That’s what makes him a successful investor.

Most people invest outside their circle of competence, and they invest in companies that they dont understand. But yet they invest in it because everybody is doing and making a quick profit.

But this is the wrong way to approach investing. You have to invest in companies that fall in your circle of competence and stick with sectors you understand.

For example, if you know more about electronics than an average person does. So you can understand in detail what type of electronics component a company produces and if their product is good quality.

You can understand the electronic company and its product much better because you know more about electronics which gives you an advantage over other investors.

Knowing your circle of competence is crucial because there are so many opportunities in the stock market to make money.

But most people fail to catch the right investment opportunity because they don’t look at their circle of competence.

You have to know what type of company you understand best and stick to investing in that type of company.

You don’t have to go outside your competence circle to make a hell of a lot of money. Instead, you can make a lot of money by investing in companies within your circle of competence.

High barriers to entry

Buffett invested in Bank of America, Citigroup, Wells Fargo, and many other finance companies. One of the reasons that he invested in this large financial institution is that it is nearly impossible for an individual to start a bank that competes with a bank of America.

The high barrier to entry gives Warren Buffett a certainty that Bank of America will be in business for many years because there is not much competition for Bank of America that threatens its existence.

But with social media companies, some guy in his boardroom may start a business that will threaten the existence of some big multi-billion company.

When it is easier for anyone to start a company in the industry, It will be hard for companies to stay in business for the long term and retain their customers. Excessive competition can eat their profits. It will be hard for companies to stay in business because of competition.

But when there is a higher barrier to entry, it is hard to start a business in an industry( banks or oil). Then there will be a certainty for investors that the company won’t go bust because of competition and probably be in business for a long time.

Avoid leverage

Most people use borrowed money to invest in risky financial assets to get rich quickly. But Buffett believes that leverage can destroy even the most sophisticated investor.

Most investors invest with leverage to maximize their returns. But they sometimes forget that leverage can also maximizes their losses.

For example, if you invest 1,000 dollars in a stock selling at 10 dollars per share. You invest 100 dollars of your own money and borrow the 900 dollars with 3 percent interest.

When the stock reaches 20 dollars per share, your investment is worth 2,000 dollars. You will return 900 dollars plus interest of 27 dollars. So a total of 927 dollars, and the rest of 1,073 dollars is yours.

Congratulation, you just ten times your money by investing just 100 dollars of your own money.

But remember, leverage may also work against you and multiply your losses rather than returns. Suppose your investment goes down from 10 to 5 dollars.

So it is worth 500 dollars, but you still have to pay the borrowed 900 dollars with 27 dollars interest. You lose all the money you invested, even if you sell the security and get 500. You still have to put another 427 Dollars to pay the borrowed amount.

Investing without leverage means you only lose what you invest. With leverage, you certainly lose your investment, and you have to pay from your hard-earned money for the borrowed amount.

Leverage is risky and can destroy the life of smart people. That’s why Buffett advised people to stay from using leverage.

“If you don’t have leverage, you don’t get in trouble. That’s the only way a smart person can go broke, basically. And I’ve always said, ‘If you’re smart, you don’t need it; and if you’re dumb, you shouldn’t be using it.’”

— Warren Buffett

Conclusion

Although, these are not the only rules Buffett follows. But these are some crucial ones that help him build wealth in the long term.

Knowing Buffett’s rules for investing is easy, but doing it requires a lot of work and patience that most people aren’t willing to do.

Warren Buffett will continue to inspire a new generation of investors to invest in quality businesses and follow his investing rules, which made him and others who follow him so rich.

Originally published on medium

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About the author

Arsalan Haroon

Writer┃SEO Expert┃Investor

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