Wealth the Warren Buffett way – a short guide to value investing
I just finished reading The Snowball about Warren Buffett so I thought I would do a post on value investing. Value investing is the stock selection strategy famously used by business magnate and third wealthiest person in the world, Warren Buffett, whose total net worth exceeds $91.5 billion.
Developed in the 1930s by Columbia University professor and economist, Ben Graham, value investing involves screening securities to find stocks undervalued relative to peers and the market. Stocks are then assessed for their intrinsic value, determined by a fundamental metric—such as the price-earnings ratio—and purchased only if the stock price is less than its intrinsic value.
With value investing, dividends, cash flow, and earnings growth matter more than market factors on the stock’s price. The idea is that the market will eventually correct—and when that happens, the undervalued stock will rise in price and the investor will make money.
Buffett’s investments have consistently outperformed the market, decade after decade, which is why he’s become known as the “godfather” of value investing.
Warren Buffett’s story
In the early 1950s Buffett enjoyed success following Ben Graham’s investing guidelines, but began to assess potential stocks differently than his mentor. While Graham kept his focus on the bottom line numbers—the balance sheet and income statement—Buffett looked at a company’s corporate leadership and overall potential to generate earnings long term.
In 1962 Buffett bought Berkshire Hathaway, a failing textile company whose shares were valued at $7.50 each. He phased out its textile manufacturing division and transformed the business into a holding company for investments. By choosing to invest in a number of assets that proved lucrative in insurance, oil, and the media, Buffett was able to build Berkshire Hathaway into the incredibly profitable company it is today.
Value investing tips
These tips from a Business Insiders article on Warren Buffett’s winning investment strategies can help you become a more successful investor.
Re-think your diversification strategy
Buffett recommends selecting stocks carefully, with an eye on the long-term future, maintaining focus on individual investments rather than hedging bets with a varied portfolio designed to minimize volatility.
Follow the 99-1 rule
Buffett warns investors not to sell as soon as it appears that a stocks’ value is declining—like the 99% do, overreacting as they take in just 1% of the daily financial news.
Play the long game
Buffett’s approach to investing requires patience and commitment. He advises investors to select stocks with potential and hang onto them for decades. Investors who constantly buy and sell may lose out on higher returns—and end up paying more trading commissions and taxes.
Get started with a formula for value investing
For more detailed information on value investing strategies—including guidelines for how to choose undervalued securities with excellent profitability potential—check out this article on Investopedia.
You might also be interested in taking a look at The Essays of Warren Buffett: Letters to Corporate America—a collection of letters Warren Buffett wrote to Berkshire Hathaway shareholders—or Ben Graham’s classic book on value investing, The Intelligent Investor.