Warren Buffett’s three best investing tips — including ‘margin of safety’ — explained

Finance news

Warren Buffett is one of the most celebrated investors in history. Many accomplished fund managers credited their success to following the Oracle of Omaha’s common sense value investing philosophy.

Buffett’s track record is unparalleled. From 1965 to 2017, Berkshire Hathaway’s rising market value generated a 20.9 percent annual return compared to S&P 500’s 9.9 percent, resulting in a cumulative gain of 2,404,748 percent versus the market’s 15,508 percent return.

CNBC researched Buffett’s strategy combing through decades of Berkshire Hathaway meeting transcripts using the Buffett Archive to find his best wisdom and strategies for the average investor.

Here is what we found.

1) Circle of competence

“Different people understand different businesses. And the important thing is to know which ones you do understand and when you’re operating within what I call your circle of competence.” — Warren Buffett, 1999 Berkshire Hathaway Annual Meeting

Buffett stressed the importance looking at companies that are within his areas of expertise to avoid large investing mistakes. He wants to know how a business makes money and be confident on the sustainability of its profit streams over the long-term. He called the process “judging the future economics of a business.”

He said if an investor is not sure if a company is within his or her circle of competence, it likely is not.

2) Piece of a business

“And I read Ben’s [The Intelligent Investor] book in 1949 when I was at University of Nebraska, and that actually just changed my whole view of investing. And it really did, basically, told me to think about a stock as a part of a business … Once you crank into your mental apparatus that 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.” — Warren Buffett, 2002 Berkshire Hathaway Annual Meeting

Buffett wasn’t born a great investor. He admitted he couldn’t make any money in stocks even after reading many investing books as a teenager.

But everything changed when Buffett read Ben Graham’s classic “The Intelligent Investor.” The book’s key tenet is to look at each stock purchase as buying a slice of a business and avoid being distracted by stock price movements.

Buffett attributed his eventual success to this investing framework.

3) Margin of Safety

“On the margin of safety, which means, don’t try and drive a 9,800-pound truck over a bridge that says it’s, you know, capacity: 10,000 pounds. But go down the road a little bit and find one that says, capacity: 15,000 pounds.” — Warren Buffett, 1996 Berkshire Hathaway Annual Meeting

When Buffett analyzes a prospective investment, he wants the value at his entry price to be much lower than his value estimate for the company. The difference between the two figures is his “margin of safety,” which limits the size of losses in case there are errors in his business analysis or assumptions.

“The margin of safety concept boils down to getting more value than you’re paying,” Buffett’s partner Charlie Munger once said.

Link to the source of information: www.cnbc.com