#5 Things Warren Buffett looks for before investing
Warren Buffett, the veteran investor and one of the richest man on this planet, is certainly an icon to look for in the investing world. The success and wealth that Warren Buffett has accumulated are really galvanizing. In this post, we are going to discuss the five important factors that Warren buffet looks for before investing in any company.
Here are 5 Things Warren Buffett looks for before investing
1. Circle of competence
Warren Buffet looks for the business he can understand and analyze. He only invests in the company that is in his circle of competence. (And it makes sense because if you can’t understand the business, then you can not forecast its future business performance.)
For example, during the technology boom in the 1990s, everyone was investing in technology stocks. It didn’t matter to the investors to understand the underlying business of the company they were investing in it. However, Warren Buffett didn’t invest in technology stocks simply saying that he cannot understand them.
He said- ‘I can understand the business behind coca-cola, automobile or textile industry. I know how they work and how they can generate profit. I can predict their growth. However, I do not understand technology companies. These companies do not lie inside my circle of competence, therefore I do not invest in them’
The technology sector was a boom in those time and gave amazing returns to everyone that invested in that sector. However, if you fast forward a few years, you will know that there was a big crash in the technology sector which destroyed the wealth of lots of people who were just following the herd mentality.
His advice to other investors- Stick to your circle of competence and do not take an irrational decision by investing in companies that you do not understand. Expand your circle of competence but do not cross it.
Also read: Top 10 Warren Buffett Quotes on Investing.
2. Management
Warren Buffett gives a lot of weight to efficient management. He evaluates the management’s rationality towards reinvesting for growth along with rewarding its shareholders. Further, he is very stern about the honesty of management.
3. Value
‘Price is what you pay, Value is what you get.’
Warren Buffet spends a lot of time reading the financials of the company. He goes through all the annual reports of the company to find its profitability, returnability, liquidity, valuation, etc. Warren Buffett always analyses the value of the company before looking at its market price. This is because he does not want to get biased by knowing the company’s market price before analyzing its financial statements.
4. Moat
The concept of the moat was popularized by Warren Buffett.
A moat is a deep, wide ditch surrounding a castle, fort, or town, typically filled with water and intended as a defense against attack. Some stocks have a similar moat around them. That’s why it’s really tough for its competitors to defeat them in its sector.
Warren Buffett always looks for a company with a wide economic moat. This moat helps the company’s business to outperform its competitors. The moat can be anything like brand value, license, patent, switching cost, etc. In addition, Warren Buffett also prefers older companies that have been public for over 10 years. He avoids buying shares in Initial public offerings.
Quick Read: 10 Must Read Books For Stock Market Investors.
5. The margin of safety
‘A good business is not a good investment if you overpay for it.‘
The concept of margin of safety was originally introduced by Benjamin Graham, the father of value investing. He was also the mentor of WarreBuffetet.
This is the central concept of value investing. Basically, this concept states that if you think a stock is valued at Rs 100 per share (fairly), there is no harm in giving yourself some benefit of the doubt (if you are wrong about this calculation) and buying at Rs 70, Rs 80 or Rs 90 instead. Here, the difference in the amount is your margin of safety.
Warren Buffett looks carefully for a margin of safety in a company before investing. He only invests if the company is currently selling at a discount.
To calculate the margin of safety, he first finds the intrinsic value or true value of the company. The current market value should be less than the intrinsic value of the company. Generally, he prefers to buy a company with a margin of safety of at least 25%.
These are the five things that Warren Buffett looks at in a company before investing. I hope you have learned a lot from this legendary investor’s way of investing.
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Comment below what factor you give most weight while evaluating a stock?
Kritesh (Tweet here) is the Founder & CEO of Trade Brains & FinGrad. He is an NSE Certified Equity Fundamental Analyst with +7 Years of Experience in Share Market Investing. Kritesh frequently writes about Share Market Investing and IPOs and publishes his personal insights on the market.
