Warren Buffett’s 3 Steps to Successful Investing
While there are entire books on the subject of Warren Buffett’s success, in this article I want to focus in on the strategy that got him started. Something that most don’t talk about is the fact that how he invests has changed. He didn’t always have billions of dollars to play with.
The strategy you use to invest a billion is very different than a million, hundred thousand, or one thousand. You see, Buffett now has enough money to buy entire companies and influence its operations. So unless you’re sitting on a couple billion, read on to learn how to use Buffett’s early strategies for yourself.
After digging through how he used to invest (before the media got wind of his brilliance), I’ve drilled down his core investing steps into 4 easy to follow steps. Don’t worry; we aren’t going to get too technical. I promise a financial jargon free explanation.
The Ultimate Investment Question
As an investor, Warren Buffett is concerned with just one question; the ultimate question:
1. Will this company continue to produce excessive cash in the future?
There are three key words in this question. The first, and most important, is the word “continue.” This means the company is ALREADY producing cash, i.e. profits. Buffett does not invest in companies that he thinks will one day be profitable. He only wants companies that have already proven themselves.
This is why you will never hear about him buying into a new technology or new company. He avoids these companies because they have such an uncertain future. He has proven that you don’t have to be invested in the latest and greatest technology to be wildly successful. It’s clear that older, less exciting companies are really where the money is.
The second key word in the question is “excessive.” Buffett doesn’t want companies that make a measly couple of bucks each year. He wants companies that make so much money, that management just can’t seem to spend it fast enough.
These types of companies are the ones who have millions and billions of dollars in cash at the end of the year and simply don’t know what to do with it. Okay, that’s a bit of an exaggeration, but you get the idea. Companies that are making enough money to pay to keep the lights on, and invest to expand their profits for the next year.
Finally, is the word “future?” No one, including Buffett can predict the future of a company. However there are several signs that can be used to get glimpse as to what the future might hold. Buffett uses these key indicators to insure that the company can sustain and increase its profits into the future.
The genius behind the greatest investor of all time lies in this simple 11 word question. I believe that this simple, yet powerful question, best captures how Buffett started his multi-billion dollar empire. The good news is that you can use the very same investment principles and techniques for yourself.
Below are the 4 steps of Buffett’s success. They are a direct reflection of the Buffett’s Ultimate Investment question. While everyone else is looking for a “short cut to riches,” you can quietly follow in the footsteps of Buffett to amass your own fortune.
3 Step Start-Up Investment Plan
The following 3 steps outline the basis for finding great investments. Investing in individual stocks can be scary when you’re first starting out. Using these 3 easy to follow steps will help find the same kind of high profit stocks Buffett invested in when he was just getting started.
Step 1: Understand the Business
Buffett only invests in companies he understands. When you invest in companies you don’t understand, say a Biotech company, it’s really hard to understand company developments. Buffett never invests in something he doesn’t understand as a way to protect his money. It’s a good rule to follow. How do you know if you understand a company? Simple, as long as you can answer these two questions are good to go:
1. Is the company better or worse than its major competitors (how much of a market leader is it)
2. How does the company make money?
Notice how hard it would be to answer these questions if you don’t understand the company? Researching how a company makes money and if it’s positioned to do well against its competitors can be as easy or complicated as you make it.
You can spend hours researching or 10 minutes outlining competitors and deciding why one company is better than another. The better you know the company and industry before you get stared, the easier it will be to answer those two questions.
Step 3: Strong Financial Base
This is the part of the process that intimidates most people when it comes to investing. Financial statements aren’t on any one’s reading list. And for good reason. They are a really boring read, not to mention how hard it is to make sense of the more complicated ones.
Alright, if your anything like me you probability don’t want to spend your Saturday afternoons analyzing financial statements. Luckily for us, finding financially strong companies doesn’t require financial statement reading any more. All we need are three metrics to insure that company is making money, and will continue to make money in the future.
The Three Power Metrics
Earnings Per Share
Price to Earnings Ratio
See my post on my favorite 3 metrics here for how to quickly find high profit stocks. Go check this post out after reading this one for a full walkthrough of how you can use those three to easily discover great investments.
Step 3: Buy On Sale
While not always part of Buffett’s strategy, this last step has become part of what he is most famous for. Remember that we make money investing in stocks when we sell them in the future. So the lower the price we pay now, the greater the profit potential. Selling a stock at $50 when you only paid $25 is better than if you’d paid $45. In on situation you make $25 a share while the other you only make $5.
The best way to insure you never pay too much for a stock is to always buy stocks when they are “on sale.” Using something called the “Investing Price” you can quickly identify companies that are on sale and pick them up on the cheap before they skyrocket in price.
This used to be the hardest part unit I put together a free Investing Price Calculator that will tell you exactly what a company is worth. Using this tool you can enter the ticker of any company and immediately known if the company is on sale. Click the link below to grab your free copy.
That’s it! The three simple steps to jumpstarting a solid investment plan. Only invest in companies with solid financials that you understand when they go on sale. Sure it sounds simple when I slap it all in one sentence; but there’s a lot behind these three steps.
Hope you found this informative and actionable. There’s a lot more to finding great investments, so use this three step process as your guide and be sure to check out other posts.