Warren Buffett (Trades, Portfolio), the Oracle of Omaha, is considered by many to be one of the greatest investors of all time. We can learn a considerable amount from his investor letters and speeches that he’s given over the years.
When you take all of his writing and lectures (as well as meeting notes from the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meetings) into consideration, there are tens of thousands of words of wisdom.
For most people, distilling and absorbing this information can be a huge challenge.
With that being the case, here are five of the most prominent investment lessons we can learn from Buffett.
Don’t lose money
Buffett’s first rule of investing is “don’t lose money.” His second rule is “never forget rule number one.” These statements need some explaining as they can’t be taken at face value.
Investors should try to avoid significant losses at all costs, but avoiding all losses is impossible.
Some investors interpret this statement to mean that, if you have a losing investment, you should never sell. This is not correct. Buffett has made some big blunders in the past, but every time he has acknowledged his mistake, sold the position, took the loss and moved on.
If you want to avoid losing money, you should only invest in high-quality companies where the risk of a permanent capital impairment is low.
Cash is king
Another Buffett lesson is to avoid debt at all costs. While some of Berkshire’s operating companies have debt, the overall group has always had a strong net cash position. The same is true of Buffett’s personal balance sheet.
Buffett likes to say he’s never borrowed a significant amount, though, as I’ve explained before, this statement is incorrect. Nevertheless, it is an excellent way to live your financial life.
Cash gives optionality and means you’re unlikely to have to make hard decisions when the market eventually turns. We don’t know when this will happen, so it’s better to be prepared at all times.
Know what you know
The best investors stick to what they know and avoid what they don’t. There are always going to be stocks that look like good buys, but if you don’t know the industry or sector, do you know what you’re buying?
You can only genuinely value a business (more on this later) if you can accurately predict future cash flows. This is impossible without an understanding of the company’s operating environment.
Buffett is more than happy to avoid companies he does not understand. Ignoring this advice from the Oracle could only cost you time and money, as well as cause frustration.
Cash equals value
Wall Street is always coming up with new ways to place a value on a business, but for Buffett, there’s only one way to value a company, and that’s based on cash flows.
Buffett uses the discounted cash flow formula to value stocks. If he can be sure a company will continue to produce a steady stream of cash for the next few decades, and he has a good idea of how those cash flows will grow, he can place a value on the business.
Other valuation metrics might cross his mind, such as the price-earnings ratio, but he’s always made it clear that the discounted cash flow method is his go-to process.
Don’t get distracted
The final investment lesson that I’m going to highlight is Buffett’s desire to not be influenced by outsiders. Whether it be Wall Street or Main Street, Buffett likes to ignore outside influences and make his own decisions based on his own research.
In today’s world, we are constantly bombarded with news and views, most of which is rubbish.
Unfortunately, that does not stop it from influencing our decisions.
Buffett realized it was better to shut off the noise years ago. He makes his own decisions based on detailed research, and there’s no reason why other investors shouldn’t follow this approach if they have the time and commitment.
Disclosure: The author owns shares of Berkshire Hathaway.
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