Secrets of Warren Buffett’s Investing Strategy
Stocks are the cornerstone of any investment portfolio. Stock are shares in the ownership of companies.
As a shareholder you are entitled to your stock’s part of the company’s earnings and voting rights.
The reason companies issues stocks is to raise money. Companies can loan money from a bank or investment firm, issue bonds or sell a part of its ownership through stocks.
Issuing stock is advantageous for the company because it does not require the company to pay back the money paid for its shares. Shareholders get in return, stock shares representing part ownership of the company with the hope that the shares will go up in value and or payout dividend earnings.
There are no guarantees when it comes to investing in stocks. Some companies pay out dividends, but many others do not. With or without dividend payouts, an investor can make money on a stock if the stock price increases in the open market. On the flipside, a stock can go down in value in which case your investment will lose value.
Stocks have historically outperformed other investments such as bonds or savings accounts. Over the long term, an investment in stocks has historically had an average return of around 10-12%.
A majority of stocks are issued in the form of common shares.
Over the long term, common stock through capital growth, yields higher returns than almost every other investment. But higher return comes with increased risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid.
Preferred stock represents shares of ownership in a company but usually doesn’t come with the same voting rights. Investors are usually guaranteed a fixed dividend forever. This is different from common stock, which has variable dividends and are never guaranteed. Another advantage is that in the event of bankruptcy, preferred shareholders are paid off before the common shareholder and after all outstanding debts have been paid. The company has the option to purchase back preferred stocks from shareholders at anytime and for any reason (usually at a premium price).
Preferred stocks are more like debt than equity. These kinds of shares can be seen as being in between bonds and common shares.
Common and preferred are the two main forms of stock issues. But companies can also issue different classes of stock. The most common is the company wanting the voting power to remain with a particular group. Different classes of shares may come with different voting rights. The two classes are traditionally designated as Class A or Class B.
Stocks are traded on exchanges. Exchanges are locations where stock purchase transactions are carried out on a trading floor. Other type of exchanges are virtual, made up of a network of computers where trades are carried out electronically. Stock market are places to facilitate the exchange of securities linking buyers and sellers.
The most prestigious exchange in the world is the New York Stock Exchange. It was founded over 200 years ago in 1792. The NYSE is home to stocks like General Electric, McDonald’s, Citigroup, Coca-Cola and Wal-Mart.
The second type of exchange is the virtual type called an over the counter market or OTC, of which the Nasdaq is well known for technology company stocks. Trading is done through a computer and telecommunications network of dealers. Nasdaq is home to several big technology companies such as Microsoft, Cisco, Intel, Dell and Oracle. This has resulted in the Nasdaq becoming a serious competitor to the NYSE.
The third largest exchange in the U.S. is the American Stock Exchange (AMEX). Most trading on the AMEX is in small capitalization stocks.
There are many stock exchanges located around the world. American exchanges are the largest. Some other financial centers are London, home of the London Stock Exchange, Toronto and Vancouver, Hong Kong’s Hang Sang, Germany’s Frankfurt based DAX, Amsterdam’s AEX, Paris’s cac, Shanghai, Tokyo, Singapore, Thailand, etc., etc.
Stock prices fluctuate daily as a result of market forces. Thismeans that share prices change according to supply and demand.
The price movement of a stock indicates what investors feel a company is worth. The price of a stock doesn’t only reflect a company’s current value, it also reflects the growth that investors expect in the future.
The most important factor that affects the value of a company is its earnings potential. Listed public companies are required by law to report their earnings four times a year at the end of every quarter and are referred to as earnings season. If a company’s results are better than expected, the price jumps up. If a company’s results disappoint, then prices fall.
Earnings are not the only reason that investors can change their sentiment towards a stock. Investors have developed many other standard variables, ratios and indicators to measure performance. One of which is the price earnings ratio.
The most common method to buy stocks is to use a brokerage. On the internet there are many online discount brokers. Most people can now afford to invest in the stock market.
Dividend Reinvestment Plans(DRIPs) and direct investment plans (DIPs) are plans by which individual investors can purchase company shares at a minimal cost. hese plans allow shareholders to purchase stock directly from the company. Drips are an efficient way to invest small amounts of money at regular intervals.
A bull market is when everything in the economy is great. There are lots of employment opportunities, business activity is improving and stocks prices are rising. Buying stocks during a bull market is easier because everything is going up. But bull markets never last forever.
A bear market is when the economy is slowing, a recession is looming and stock prices are decreasing. Bear markets makes it difficult for investors to pick profitable stocks. One way to make money when stocks prices are falling is by using a using a technique called ‘short selling’ or investors can simply wait on the sidelines until they feel that the bear market is nearing its end, and then begin buying stocks again in anticipation of a new bull market.
There are many different investment types and strategies. Money can be made from the changing cycles in the market.
Stock market are by nature are unpredictable. The best investment strategy is to hold long term quality core investments as they remain the best defense against a roller coaster stock market. They are not immune to events such as the financial crisis in 2008, but they do weather the volatility better and are among the first to advance when economic conditions improve.
Long term investors can best focus on a portfolio of core holdings and stay with them as long as the company qualifies as a core holding. A core holding is a mature company with a strong competitive position. Keen investors look to buy them at a discount to their intrinsic or fair value whenever the opportunity presents itself.
Core tier investment companies do not generally soar to the skies when the economy is expanding but they also don’t fall too steeply when the stock market values are falling.
If you wish to risk a small portion of your portfolio on potentially high-growth companies, understand that many of the companies that fit this description collapse when the economy is in headed towards recession.
It is difficult for any investor to watch the market collapse as it did in 2008. The temptation is to sell and get out. Investors who did sell at the bottom lost out as the markets recovered shortly after and continued on with record gains. If you have a strong package of core holdings, you are better off staying in the market and waiting for the turnaround rather than pulling your money out at a loss and then trying to buy back in as the market goes up.
A company identified as a core holding today may not be so tomorrow, so long-term investors must constantly review their portfolio holdings. Give yourself enough time so that when you need to sell, it is at a time of your choosing.
For example, if you were retired or nearing retirement and needed to cash in your stock, 2008 would not have been a good time to do so.
Look five years into the future before you need your money and then invest in the stock market. This will give you enough time to sell when it profits you and not when you have to sell.
Taking control of your personal finances will take work. But the rewards will far outweigh the effort. You don’t have to let banks or investment professionals put your money into investment vehicles that you do not understand. No one knows better than you what is best for your money.
There are different ways to invest. They include investing your money in stocks, bonds, mutual funds and ETFs, or starting your own business. It doesn’t matter which method you choose, the goal is to put your money to work so it earns you an additional profit.
Investing is not gambling. Gambling is putting money at risk by betting on an uncertain outcome with the hope that you might win money. Investors must perform thorough analysis and commit capital only where there is a reasonable expectation of making a profit. There will be risk and there are no guarantees.
Albert Einstein called compound interest “The greatest mathematical discovery of all time”. Compounding can be applied to your investment earnings to astronomically grow your net asset worth.
The magic of compounding transforms your working money into a powerful income-generating tool. Compounding is the process of generating earnings on an asset’s reinvested earnings. To work, it requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment. This increase in the amount made each year, is compounding in action: interest earning interest on interest and so on. This will continue as long as you keep reinvesting the earning on your investments. The time element means that the longer your investment can accumulate the greater your investment will grow. Start early with investing and let the years work to your advantage.
As you invest, compounding your earnings amplifies the growth of your working money. Just as investing maximizes your earning potential, compounding maximizes the earning potential of your investments exponentially. Time being the exponential factor that makes compounding work. However your investment and earned income must remain invested over the entire period.
Safety of capital, investment income and capital gains are factors when deciding how to invest. A person’s age, career choice and personal situation should also be considered. For the elderly or already retired investment income is a top priority. Younger people have more time to let their investments grow.
An investor’s financial position will also affect their financial objective.
For people getting close to retirement age, it is important that they safeguard and increase their savings. When you retire you will be accessing your investments funds so you don’t want to expose all of your money to too much risk.
When compared to other investments, stocks can provide for high returns. However you should accept the fact that the higher the potential return on your investments that your degree of risk also increases. Stock prices do not go up in a straight line. There will be times when you investment value will decrease. The trick is to choose the highest quality stocks that can weather the storms and survive to be around for a long time.
There are many alternatives types of securities and investment strategies. From futures and options trading, gold and real estate, commodities and metals to complicated derivative products.
You should not choose for alternative investments at the beginning of your investing career until you become a seasoned investor with years of experience. These investments are high risk/high reward securities that are much more speculative in nature.
New investors should concentrate on building a solid financial foundation and asset base before speculating. Good investing is not a ‘get rich quick scheme,’ and investors should keep both feet solidly planted on the ground so as to not get blown away by the risks and volatility of high flying complicated investments when they crash land.
Asset allocation and diversification are important. It basically means not putting all of your eggs in one basket. By spreading your investments across various types of assets and markets you reduce the risk for financial losses.
Before investing in a company, investors should do due diligence to ascertain the fundamental value of a potential investment. By analyzing a company’s fundamentals, investors can determine whether a stock’s intrinsic value is more than the current price that it is trading for. If this is so then chances are it will be a profitable investment.
A business enterprise is all about profits. Simple revenues minus expenses equals profit – the basis of intrinsic value.
A successful company must have strong management. Management make strategic decisions that are a crucial factor determining the direction of a company. To better understand the strength of a company investors should dig deep into the management structure. Ask questions such as:
Who is the chief executive officer, the chief financial officer and other leading executives? Who are the board members and advisers and what backgrounds do they come from? What is their education and employment history? What has brought these individuals to a particular company and is there management style succeeding?
What is the management style and philosophy and expectations for the company? How long has current management been in position and if not long why the changes in management? Have the new managers had past career successes and what were those achievements?
Another factor to consider when analyzing a company is its product and or services. What is the company’s business model and how exactly does it make a profit.
Know what a company’s activities are and how it generate revenues. By gathering information and understanding how a company works, investors will be able to tell if management is making good decision and determine the fundamental worth of and earnings potential.
Investors should also analyze the characteristics of the industry and its growth potential. An industry fast declining due to technological changes could make for a poor investment.
A popular brand or trademark company reflects years of product development and marketing. Having a stock portfolio of popular brands and trademark products diversifies risk as the good performance of one brand can compensate for underperformance elsewhere.
You don’t need to be super smart in finance to recognize a good company. You can easily spot companies that are expanding and doing well. Do some research and you will be surprised at what you can discover.
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Investments – Lecture 01 – Introduction
This is an introductory lecture in Investments. It reviews the very basics, mostly elementary concepts that should be familiar from an introductory course in finance or corporate finance.
Investments – Lecture 02 – The Investment Process
Continues to cover Chapter 1 from “Investments” by Bodie, Kane, and Marcus. Diversification, risk, asset classes, asset allocation, active and passive investment strategies, primary and secondary markets.