Warren Buffett is one of the few investors in the world that has consistently succeeded where others failed. Part of his success is due to his common sense approach to the stock market. Investors have mocked Buffett for his old fashioned approach to investing when he sat out the dot com era bubble. But Buffett had the last laugh when others lost out during the bust.
Buffett also managed to largely avoid the major losses investors faced when they invested in securities dependent on subprime lending practices. In fact, he managed to profit from it.
Here are some principles Warren Buffett follows and investors would be wise to model:
Lesson #1: Invest in solid companies when others are running the other way.
"A public opinion poll is no substitute for thought" - Warren Buffett
Warren Buffett does not pick stocks based on television show recommendations, nor does he follow what the media and people have to say about the stock market. In September 2008, Lehman Brothers collapsed and investors were bailing out of the stock market. Analysts predicted the next great recession. What did Warren Buffett do? He pumped in five billion dollars of his own money into Goldman Sachs Group, Inc. (GS)! Why? Goldman Sachs was a solid company. The misfortunes of one company did not mean the others were similarly doomed. While his large investment was meant to give investors confidence, it also paid off handsomely for Mr. Buffett. One year later, in September 2009, Buffett saw a 3 billion dollar return in profits.
It's easy to say in hindsight that the choice was obvious to invest in a solid company, but a public opinion poll would have told you that the stock market is no place to have your money during such volatile times. Everyone at that time was taking their money out of the market and placing it in United States Treasury Bonds that paid hardly anything. While most investors today have seen maybe a 1% return on their "safe move", Warren Buffett saw a 60% return in the middle of a recession.
Lesson #2: If you don't understand the math, don't buy it
"Beware of geeks bearing formulas" - Warren Buffett
Several investors fell into the trouble in 2008 when subprime borrowers stopped making payments on their mortgages and the investments based on those loans started failing. The actual explanation is a lot more complicated because the investors were led to believe they were investing in low risk securities when a close look showed that they really had no idea where their money was going. That's because derivative investments split up loans into several pieces and reassembled them, making it impossible to find out the actual risk behind the security. Normally people would not invest in unknown risks, but they trusted the math. After all, it had been working well and no one saw why it wouldn't continue working.
Warren Buffett did not invest in such schemes, not because he knew better, but because he just didn't know. When you don't understand an investment, save your money for something that makes sense to you.
Lesson #3: Invest for the long-term
"Our favorite holding period is forever" - Warren Buffett
Warren Buffett's style of investing is called value investing, which means examining a company for core fundamentals and then purchasing the stock price at a good value. Once he gets a stock that he likes, he holds onto it until the price goes as high as he think it will go. This form of analysis is simple in principle but requires a lot of research. Who manages the company? Can they pay those profits back to investors? Does the company have a solid business model?
This same approach caused Warren Buffett to invest in Burlington Northern Santa Fe (BNSF), a railroad company, in November 2009. Railroads are not a high tech industry and don't get a lot of press, but Buffett saw this company was undervalued and has made a bet that in the long-term, be it a year or 10 years, the company will be worth a lot more because it has strong fundamentals. Analysts believe Buffett has invested in BNSF because it transports coal, corn, wheat, fuel and other major commodities. When the economy turns around, BNSF will have more shipping business and Buffett will be there to profit from their earnings.
Warren Buffett is very secretive about his actual stock investments, so while you can never hope to buy a stock at the same time he purchases one, you can learn the philosophy that guides those decisions.