How to Pick Stocks Like Warren Buffett

Dabbling in stock market is a great financial move for people who have extra fund to spend. If you invest your money now, you will reap the benefit later in bigger amount than where you have started. However, you should always remember one thing: stock market investment is risky. The risk of experiencing failure is something inevitable. The only thing that you are able to do is minimizing the risk as low as you can manage. Learning some investment tips from renowned investors might be able to help you kick start this venture.

Among world famous investors, Warren Buffett is without doubt the most attractive one. He is dubbed as Oracle of Omaha because of his ingenuity in predicting the stock market. As of today, the net worth that the investor has gathered is close to $83 billion. He aims to distribute his wealth by donating to various charities. His success does not come out of nowhere. He has gathered vast knowledge about investment world from his long stint in it.

8 Important Tips to Select the Right Stock from Warren Buffett, The Master of Investments

The investor has stated that one major point in making investment is picking the right stocks. Stock market is saturated with tens of thousands stock products. Not every stock that you see will yield satisfying results. In some cases, you might even see loss of investment because the stock price drops unexpectedly. The following tips from Warren Buffet might be able to help you navigate the world of investment.

1. Looking closely at the intrinsic value of a stock

When you are determining whether a stock is worth buying, you should look closely at its intrinsic value instead of indicators that are immediately visible. The intrinsic value can be defined as the real value. To see the real value of a stock, you need to consider not only factors that are tangible, but also those that are abstract. The tangible factors are often in quantitative form. You will gain this information from looking at the financial statement of company which stock you are about to purchase.

Meanwhile, the non tangible factor includes the business model employed by company, governance situation, and certain market factors. Market factors that are usually considered in the process as calculating stock’s intrinsic value is the market trend and economic growth. The two groups of factors will give you information if the price applied to that stock is appropriate. Such information is not only going to help you deciding whether to buy the stock. It also helps you in the negotiation process, if you see that the stock has promising future but you are not willing to splurge as much for it.

There are three common strategies used to evaluate the intrinsic value of a stock.

Discounted Cash Flow Analysis; this method utilizes company’s weighted average cost of capital to project its cash flow in the future then discount it at certain margin.

Precedent Transactions Method; this method compares company that offers stock to other businesses within the same industry that are acquired or sold in recent time.

Comparative Analysis; using this method, you are comparing the stock to other stocks from companies that have similar financial standings by analyzing the trading multiples.

2. Analyzing the company’s performance

The company’s performance can provide information about how it is going to grow, which means that if you are purchasing the company’s stock you will gain the benefit. This information is obtained by studying the financial statement. You need to interpret the document to determine the financial soundness and profitability of a company. If the company’s performance does not imply those two indicators, then you should reconsider investing in that company.

In order to do valid company performance, there are six steps that you need to undergo.

Identification of the economic characteristics of said company.

Taking note of the strategies that the company employs so far.

Deciding whether the financial statement is up to industry standard or not.

Conducting profit analysis and current risks faced by the company.

If possible, analyzing for the projected financial statements provided by the company.

Determining the value of that company.

3. Delving into the profit margins

You should take a look closer at the profit margin of the company. The profit margin displays the amount of money that a company is generating at given time. When purchasing stock, you need to choose one that has good profit margin. However, determining the good profit margin is not as simple as seeing plain percentage. You have to consider the company’s industry as well. Each industry will have its own range of good profit margin.

There are three major types of profit margin known in the business.

Net profit margin; the calculation for net margin is very complicated because detailed incomes and outcomes must be compared with the revenue.

Gross profit margin; this margin can be calculated very easily by deducting gross revenue with cost of materials.

Operating profit margin; this is an important data that calculates operational costs, administration costs, and marketing expenses against the company’s revenue.

It is important to look for all of those margins prior to purchasing the company’s stock. The margins should be healthy and follow the industry’s standard. You should also see the company’s strategy to tackle issues with its profit margins.

4. Checking the company’s debt situation

In large company, having a debt is almost inevitable. The company needs to take loans to maintain its day to day operation as well as planning for its future. Company’s debt should not be something that hinders you from purchasing the company’s stock. What you need to check is how the company manages its debt. Company with good debt management will be a good choice in the long run. The simplest way to see whether a company has good debt management is debt ratios.

There are three common types of debt ratios that you should know prior to investing in a company.

Debt-to-equity ratio; the ratio is obtained by comparing the company’s long term debts with equity of shareholders.

Quick ratio; this ratio provides information about the ability of a company in paying short term debts without having to sell its assets.

Current ratio; this ratio is calculated by making comparison between its short term assets and liabilities to determine how well it will be able to pay off short term debts.

In addition to looking at those ratios, investor would be better of checking the qualitative aspects of the debts. You need to see the kinds of debts the company is having, including information about their terms and interest rates. You should also see the purpose of each debt taken.  If the company uses it to pay off its previous loans, then it will be better to avoid buying the stock. Healthy debt is usually used to fund the company’s growth.

5. Analyzing the reliance on commodity

The market is quite volatile these days. It is especially the case with commodities. Beginner investors are usually advised against doing it because there are many unforeseen factors that can play role in the stock price, namely: climate, political stability, technology developments, economic inflation, and even something as menial as foreign events. If you are not well versed in the market, you will face immense risk, especially against people who have dabbled in such business for longer time.

Warren Buffett once explained that he avoids investing on companies that rely greatly on commodities. This includes fashion companies and food manufactures that have not been long established. It does not mean that he totally avoids companies that produce goods, though. What an investor should look is whether the company relies heavily on certain commodities that will be hard to source in certain situations. If so, the company will have a hard time when those commodities are scarce.

6. Choosing to invest in something you understand

There is one important point that will encompass all other points within this list: understanding the industry that you are investing in. This is a common mistake for beginner level investors. They tend to look at the surface performance of a company. When investor does not understand how the industry works, they will not know how the money is produced. They cannot project how the financial situation would be in the future. 

Warren Buffett introduces a concept named circle of competence. This circle encompasses businesses that investor understands completely and perhaps even often works with. If you are working in pharmaceutical industry, then you will have easier time when investing in pharmaceutical companies. It is because you understand the process of manufacturing drugs, marketing the products, as well as the consumer behaviors. Such information can help you evaluate how a pharmaceutical company performs and will perform in the long run, thus determining whether buying the stock would be worthy.

7. Observing how the management works

The downfall of a company is often determined by its management. A healthy management will ensure that the company stays on track so that its milestones would be achieved at given time. Meanwhile, company with bad management must be avoided because they will not last long in the cut-throat business environment. It is quite difficult, though, to decide whether a company has a healthy management. You need to observe the company for certain period and the indicators might not be presented in quantifiable data.

First, the company’s leaders should have leadership styles that are effective to the organization. It can be observed from the behaviors and performance of the company’s employees. The capability to churn up high quality innovations consistently often indicates that the company has good leadership. It is also important to see the happiness of the employee. This particular indicator is very subjective. You may need to see news or even visit the company on your own to determine whether the employee’s life is fulfilled while working at the company.

Another sign of healthy company management is its focus on the main purpose. Good company will always have its own visions and values. A company that works according to its original concept and reinforces its values continuously tends to have stable market and consistent growth. However, the management should also be adaptable to the change of environment. This characteristic can be seen from how the company deals with unexpected problems as well as how it uses opportunities presented. To get such information, you might have to look at the company’s history.

Last, but certainly not least, an investor must see if the management is realistic. Sometimes, there are companies that will gloss over its reports in order to make it more appealing to investors. You should avoid such companies at all cost. Instead, you should look for companies that can present its difficulties honestly. However, those companies must be able to come up with sound solutions to their problems so that you can be assured that they can handle your investment well.

8. Maintaining mindset that the investment is for longer term

You have to grow a mindset that the investments you have made are for long term. When it comes to dealing with stock market, there are many beginner investors who get swayed by the slightest change in the market. As an example, inexperienced investors will tend to sell their stocks when the price is plummeting for fear that it will go even lower. In other cases, investors will blindly purchase new stocks which price is climbing without considering the future probability. Such short term mindset is dangerous, especially if you invest most of your fun in stock market. 

There is one investment strategies that Warren Buffett suggested. Value investing is the first and foremost investing strategy to apply, especially in your starting point. It means that you are purchasing stock at lower price than its value. To do this, you have to make use of the tips explained above. The careful research will tell you which stock to purchase and when to it. Such stock will take long time to experience price rise. However, as you wait patiently, you will find that after long years your return of investment is very high.

Of course, there are other strategies to employ depending on what your financial objectives are. You can try income investment, growth investment, and socially responsible investment strategies if you think they suit you better. The tips above can be applied regardless of the strategy that you are using. Investing smartly is more important than pouring all of your funds.


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