6 Investment Lessons From Warren Buffett | How to Find Long-term Market Winners?

For the Investors Shaken by Current Weak & Volatile Markets

Introduction

Are you among the investors shaken by the current weak and volatile markets? Here are the 6 investment lessons from Warren Buffett, the Legendary Investor. Today, NIFTY ends at 3-year low for the first time since March 2017, amid escalating fears of economic dislocation due to coronavirus outbreak. In this bear market phase, how should a retail investor find the long-term market winners?

6 Investment Lessons From Warren Buffett – How to Find Long-term Market Winners?

Finding Value Stocks Amidst Recent Market Declines

• We all know Mr.Warren Buffett Warren is the man to look up to when we think of value investing. A follower of Benjamin Graham, the father of value investing, Buffett has become more famous than his teacher by developing on Graham’s teaching.
• What is Value Investing?
  • Value investing is a long-term strategy which focuses upon a thorough analysis to identify and then purchase those stocks where the market price is below the stock’s intrinsic value.
  • The main idea is to buy a stock for less than it is truly worth according to the firm’s financial statements in the expectation that over time this intrinsic value will be recognized by the market.
• Margin of Safety
  • Since value investing focuses on putting our money in a stock which is at a low, the chances of further suffering a price depreciation is much lower as compared to investing in normally- priced stocks.
  • If a stock has an intrinsic value of Rs.100 and is currently trading at Rs.60, then the Rs.40 difference is a surety that you will make more profits than someone who has bought the stock at its value. This is called the margin of safety and is a key contributor in value stocks making more profits.
• What is a Value Stock?
  • Value stock is a stock which trades at a valuation lower than its underlying/ intrinsic value.
  • There are 2 ways to calculate Intrinsic value of a stock to check whether the stock is undervalued or not :
    1. Determine Future cash flows of the company and then calculate Present value of the net sum of all the future cash flows of the company
    2. Determine the Historical Average Price to Earnings Ratio of the company

Warren Buffett’s Letter to Shareholders 2020 

• Each year, Warren Buffett writes an open letter to Berkshire Hathaway shareholders. Over the last 40 years, these letters have become an annual read across the investing world, providing insight into how Buffett and his team think about everything from investment strategy to stock ownership to company culture and various global market triggers.
• Here are the 6 investment lessons from Warren Buffett’s Letter to Shareholders. These lessons are the investment strategies for current bear market, which will help you find the long-term market winners.

1. Focus on Operational Earnings

• As a long-term investor, you should focus on what the Business is doing and not on how stocks react in current high market volatility.
• Never mix market volatility with business outlook of the particular company. Ideally, you should ignore the short-term market volatility.
• It is because, a stock will be volatile in the short-run, but sound businesses have high probability of doing-well “over time” 

2. Power of Retained Earnings

• Well-managed Industrial companies don’t distribute whole of their earned profits as  dividends to their shareholders.
• Since. the retained Earnings that are re-invested well, compounded well can create great wealth over longer horizon.
• Power of Compounding works in favour of a sound industrial investment. So look for the businesses with high Return on Capital Employed and Return on Equity ratios (Both ROCE, ROE should be greater than 20%).
• The best way is to check for companies that don’t pay dividends but reinvest their retained earnings well.

3. How to Invest Your Surplus Money?

• When searching for stock ideas, you should first look inside your existing portfolio.
• Avoid too much diversification in the portfolio, since it will dampen the overall performance of your portfolio.
• You should link your Financial Goals with relevant type of Asset Classes.
• Early Realisation of Financial Goals can be achieved by Investing Surplus Money with the Existing Asset Allocation in your Portfolio. It can also help you achieve a financial freedom earlier.

4. 3 Criteria Before Investing in New Businesses

• Mr. Warren Buffett said, “One should always look at a company as a business and not merely as a stock.” Thus, he has laid down 3 important criteria before investing in a new business.
  1. The business must earn good returns on the net tangible capital required in their operations. ie. Return on Capital Employed (ROCE) > 20%
  2. It must be run by able and honest managers. It means the businesses should have a good Corporate Governance.
  3. And It must be available at Sensible Price. Even though Mr. Buffett is a firm believer in stocks outperforming all other asset classes over the long term, he is still quite the stickler when it comes to valuation. So, an investor should never go with Euphoric Market Valuation even for a business with strong fundamentals.

5. Follow a Disciplined Investment Approach

• In the world of stock market, everybody makes mistakes. So, don’t get dishearten with your mistakes.
• Just follow a Disciplined Investment Approach in weak and volatile markets also. Do continue with your existing SIPs towards your long-term financial goals. It will help you to take the advantage of Rupee Cost Averaging by buying more units in falling or bear markets.
• Simply follow the above mentioned checklist while Making Investing in New Businesses :
  1. ROCE > 20%
  2. Able & Honest Manager
  3. Sensible Valuation

6. Equities will always outperform Fixed Income Securities in the Long-term

• When you invest directly into the Equity and Equity-related instruments, you become the part-owner of the profits (or the losses) of the business.
  • In case of Equity Financing, there is no third party in between the you and the company you invested in.
  • So, You can have higher returns from your equity investments over the longer horizon as the business is going to expand and create wealth for its shareholders in long-term.
• On the other hand, when you invest in Fixed income securities like Bank Fixed Deposits, the banks are directly providing the debt financing to the businesses.
  • The funds lended to the company by the banks are from your deposits. Here, bank is an intermediary for financing between you and the business.
  • Thus, the bank will take its interest margin and your overall return on FDs will go down as compared with Equity Financing case mentioned above.