How to Invest Like Warren Buffett – For Beginners That Want Some Insight

At the core of all Warren Buffett’s investment decisions is a business man like outlook on stock purchasing. In Warren’s mind, he is not buying a stock ticker; rather, he is buying an actual piece of a company.

So he first analyses the product, the business model that surrounds that product and then the underlying economics that underpin that business model. And if he likes what he sees, then he starts fiddling around with the profit numbers and earnings projections.

Warren likes a business that he can understand. But for Warren, this has a deeper business meaning. A business that he can understand is one in which it has a product or service that does not have to change in order to sell. To Warren, a predictable product equals predictable profits. Coke is fine example of this. The cola product has been the same for over 100 years, so it’s not unreasonable to suggest it will be the same for the next 100 years. This gives Warren better insight in how to forecast future earnings.

Next, Warren needs the business model to have a durable competitive advantage. It is the nature of capitalism to want to crush the other guy. So this is Warren’s stress test. He wants to see if a competitor had 8 billion dollars, what could they do with it? Could they make a dent in the company he wants to invest in? So if Pepsi had 8 billion dollars, could they dent Coke world wide? The answer is a resounding no.

Competent Management is critical in forecasting the performance of future cash flows. Warren understands human nature, in that; people are always compelled to do something stupid when a huge pile of cash is on the radar screen. Bank management is a striking example of this. For this reason, he wants management with a history of having integrity and common sense with respect to how business affairs should be governed. This means no 40 to 1 leverage ratio, no crazy loan portfolio, etc.

Price for the world’s greatest investor needs to be sensibl! e. He us es a discounted cash flow model with a discount rate of 10%. If a company has stable predictable growing earnings and these earnings are protected with a durable competitive advantage than he is willing to pay a premium. His acquisition of Burlington Northern Sante Fe is a good example of this. The railroads can’t be out sourced to India.

In my next article I will talk about discounted cash flow models and finance math and do my best to explain it in basic terms for the beginner investor. This article was just meant as a blueprint for sound investing methods, ones that Warren Buffett subscribes to himself.

Cheers!