Warren Buffet's Investing Secrets

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As the stock market hits new 52 weeks lows, fear is in the streets (as represented by the CNN fear and greed indicator below):

Yet for long term investors, it’s important to understand that these are the times to start investing capital in good companies.

I mean, one of the best modern investors of our time, Bill Ackman (who just made $2.7 billion by hedging rate hikes) just said:

”You can do very well as a stock-market investor if you find really high-quality companies, and you buy them at attractive prices. I think today is a pretty good time. March of 2020 was obviously a very, very good entry point. I think this is another moment where it's a pretty good time to commit more capital to equity markets.”

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When I talk about good companies, I’m not talking about the ARKK 0.00%↑ stocks of this world. Though they may seem attractive at times due to their outperformance of the market, they aren’t what an investor should be looking at.

ARKK 0.00%↑ chart, though attractive in 2020 and 2021, would have screwed over long term investors over time, closing the last 5 years at an overall loss of -2.44%.

 Obviously, everybody knows about Warren Buffet, but that popularity isn’t without reason. Take a look at the performance of Buffet’s Berkshire Hathaway below:

$BRK.B is currently outperforming even the S&P 500 on a long term basis!

But the real question to ask is: how does he do it?

The key lies in Buffet’s interviews and shareholder letters, so here are some of his top secrets to invest like he does:

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1. The Generals

   "Diversification is a protection against ignorance," Buffett once said. "[It] makes very little sense for those who know what they're doing."

   Buffet’s “Generals” consist of 5 or 6 stocks that make up the majority 50% of his portfolio and the other 30% in other companies.

   This means he is looking for high quality companies which have a very little chance of going down, and though they may be considered “boring“, they are market leaders and keep his portfolio outperforming.

2. Margin of Safety

   The margin-of-safety rule essentially means that if the income + assets of a company are less than what the shares are trading at, that is your margin of safety.

   

   
   Essentially, you are looking for stocks that have more assets than what the market is currently pricing in. This is your “margin of safety“ and helps to prevent significant drawdowns.

   Buffet likes a margin-of-safety of around 30%.

3. When He Sells

   There are three reasons Berkshire Hathaway will sell a stock:

   1. They need the money for a more attractive opportunity

   2. The stock has changing fundamentals

   3. The landscape of the industry has changed

   “The most important thing to do if you find yourself in a hole is to stop digging”.

   A few years before the financial crisis, Buffet bought a large position in Freddie Mac, the mortgage agency, yet sold uncharacteristically fast after the management of the company started doing things he wasn’t comfortable with and just didn’t make sense. Now, Freddie Mac is a penny stock that trades over-the-counter at $FMCC.

4. Contention doing Nothing

   "It has struck me that all men’s misfortunes spring from the single cause that they are unable to stay quietly in one room.” - Blaise Pascal

   One of the biggest secrets for both long term investors and short term traders lies in doing nothing when there is nothing to do. From 1975-1985, Buffet did nothing, yet was able to compound returns at an astronomical rate.

   The news likes to focus on what traders are doing, but don’t forget what they aren’t.

5. Seize Opportunity

   In times like today, when you see the market down 25% or more since the start of this year, it’s tempting to read the fear online and want to sell your assets. Yet, much of his success comes from buying these dips (with cash he has present due to rule #4 above) and holding. In the 2008 financial crisis, Buffet took a $5 Billion deal with Goldman Sachs and netted huge gains while the sector recovered.

   He did this by investing in a good company that was being dragged down by the rest of the industry.

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   Those are 5 rules I think are important for investors to know before investing in a company. Of course, you could just buy $BRK.B or SPY 0.00%↑ for a safer, pre managed version of this entire article, but I think these rules are great to know.

   Thanks for reading,

   -Adit Dayal.