Buffett’s 3 Best Rules for Stock Investing

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In 2018, business news leader CNBC examined decades of public comments by Berkshire Hathaway’s hugely successful CEO Warren Buffett to learn what’s behind his remarkable investing accomplishments. It came up with his three core recommendations for buying stocks.

These are:

  • Invest within your circle of competence.
  • Think like a business owner when buying equities.
  • Buy at inexpensive prices to provide a margin of safety.

CNBC noted that from 1965 through 2017, shares of Buffett’s Berkshire Hathaway Inc. (BRK-A) delivered a compounded average annual return of 20.9%, more than double the 9.9% return for the S&P 500 Index (SPX).

The upshot was that the cumulative gain for Berkshire Hathaway stock was 155 times greater than that for the S&P 500 over that period.

Read on for more on Buffett’s three best investing rules.

  • Warren Buffett’s public comments can offer valuable investment insight.
  • Three key Buffett rules for buying stocks have helped propel Berkshire Hathaway’s returns.
  • Buffett’s circle of competence rule relates to buying stocks in companies that you understand.
  • He believes that stock investors should be more concerned about a company’s business than short-term stock price volatility.
  • Buffett has long been a proponent of value investing.

1. Circle of Competence

Buffett believes that investors should avoid going too far afield from their expertise when buying stocks.

Instead, before they buy, investors should make sure that they fully understand how a business operates, how it makes money, and the future sustainability of its business model and profits. He referred to this as “operating within what I call your circle of competence” during the 1999 Berkshire annual meeting.

With the notable exception of smartphone and personal computer maker Apple Inc., Buffett passed up on a number of winning investments in the technology field precisely because he did not feel sufficiently competent to judge their business models.

Berkshire Hathaway increased its stake in Apple over time. In June 2023, it owned 5.8% of Apple’s outstanding shares. Apple stock made up 50% of its stock portfolio.

2. You’re Buying a Business

A second key insight that Buffett gained as a college student in 1949 came from reading The Intelligent Investor, the seminal book by value investing pioneer Benjamin Graham.

As Buffett said during the 2002 Berkshire Hathaway annual meeting, “You’re not looking at things that wiggle up and down on charts, or that people send you little missives on, you know, saying buy this because it’s going up next week, or it’s going to split, or the dividend’s going to get increased, or whatever, but instead you’re buying a business.”

The key tenet of Graham’s book is that buying stock makes you a part owner of a business. As such, you should not be concerned about short-term fluctuations in stock prices.

Indeed, Buffett believes that such price movement, typically referred to as volatility, represent temporary “noise” that should be ignored by long-term investors.

3. Margin of Safety

A third rule that Buffett learned from Graham is to buy stocks with a large margin of safety. That is, investments that sell significantly below their intrinsic value.

This bargain-hunting approach to investing should limit your potential losses in case your estimate of intrinsic value was too high, or if unforeseen events damage a company’s once-rosy prospects.

Coming up with an accurate estimate of intrinsic value is not easy. But the Graham method, as employed by Buffett, rests on rigorous fundamental analysis of the data pertinent to a company, its industry, and the general economy.

Buffett stands out among investors in his decades-long ability to make astute judgments of value.

From 1964 to 2022, Berkshire Hathaway’s overall return was 3,787,464%. The return for the S&P 500, including reinvested dividends, was 24,708% for the same period.

Other Advice From Buffett

Never Look at a Headline

For the average investor who lacks Buffett’s analytic prowess and sharp eye, casting their lot with the long-term prospects for the U.S. economy and the U.S. stock market may be the safest bet.

“The best single thing you could have done on March 11, 1942–when I bought my first stock–was buy a stock index fund and never look at a headline…as if you had bought a farm.”

Buffett noted that a theoretical $10,000 investment in an index fund back then would be worth more than $51 million in 2018, including reinvested dividends.

Make the Most of a Good Opportunity

This ties into a well-known saying of Buffett’s. “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

Take advantage of solid investment ideas whenever you can. And invest as much as you can because they won’t always be available. Lower values and a drop in prices may not return.

Temperament, Not Intellect, Is Key

Keep a cool head when others around you are madly buying or selling. That’s what makes and keeps investors successful.

It’s vital to analyze and understand what’s happening with a company and its business. Resist going with the herd or with popular mouthpieces who call for particular actions.

Remain objective and leave emotions out of your research and investment decision-making.

Buffett’s Winners

With market values as of March 2023, the biggest winners in Berkshire Hathaway’s stock portfolio since purchase are:

Coca-Cola (KO)

  • Cost: $1.3 billion
  • Market value: $24.8 billion

American Express (AXP)

  • Cost: $1.3 billion
  • Market value: $24.0 billion

Moody’s (MCO)

  • Cost: $248 million
  • Market value: $7.5 billion

Apple (AAPL)

  • Cost: $30 to $35 billion
  • Market value: $151 billion

Buffett’s Losers

To be sure, Buffett has chosen a number of losers. His worst performers year-to-date through November 2022 included:

Snowflake (SNOW)

  • Change: -58.4%
  • Unrealized loss (in millions): -$1,210

Nu Holdings (NU)

  • Change: -55%
  • Unrealized loss (in millions): -$553

RH (RH)

  • Change: -48.7%
  • Unrealized loss (in millions): -$616

Floor & Decor Holdings (FND)

  • Change: -45.5%
  • Unrealized loss (in millions): -$282

What Does Warren Buffet Look at When Choosing Stocks?

Among other things, he looks at company performance and for a reliable return on equity, the amount of debt a company has relative to equity, profit margins, the uniqueness of a company’s products or services, and whether the company has a competitive advantage.

Does Buffett Own All of Berkshire Hathaway?

Warren Buffett owns 15.6% of Berkshire Hathaway and controls 31.5% of the voting interest. He is the largest shareholder.

How Old Was Warren Buffett When He Started Investing?

According to Buffett, he purchased his first stock when he was 11 years old, in March of 1942.

The Bottom Line

Through the years, Warren Buffett has been generous about sharing with the general public his accumulated wisdom about investing. His enviable overall investment record confirms how valuable his key investing rules can be if adhered to over time.

The remarkable price of Berkshire Hathaway stock ($550,341 per share as of Sep. 22, 2023) reflects Buffett’s investment success, as well as his contribution to the companies in Berkshire Hathaway’s portfolio and to the wealth of his long-time shareholders.

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