Warren Buffett believes investors should buy stocks within their “circle of competence” and at attractive values to succeed in the stock market.
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
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
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
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.
