Nobody knows for sure the techniques and methods of Warren Buffett. But we can understand a lot from the way he goes about it. Here is a list of principles gleaned from what Warren Buffett practices:
- Look at how the company is managed. Now you would think that if you knew about management, you would have started your own business. But fortunately, you can apply some tests to check it out. First, if a company buys its shares back once in a while, it is a sign that it is being managed well. But these share buybacks should be at a price less than intrinsic value of the shares. Many companies buy back shares just to artificially drive the price of its stock up, and such companies are the worst choice for investment. Second, do they meddle with things that are not their core business? That is a sign that they are not being managed well. Any company worth its salt would concentrate on its core business and if the promoters want to venture into other fields, they would start a new company.
- You should invest in only those companies, whose businesses you understand. You can not take an informed decision about a company, if you don't understand how the world, economy, government decisions, and other factors influence the business prospects of that particular company. If you can not devote too much time on learning, concentrate on companies with simple businesses.
- Obviously, the company should have a history of consistent high returns. It is not necessary that a company with good returns in the past would again post good results, but it indicates that the company is under able managers which increases the probability of similar returns in future.
- Most important of all, you should buy stocks that meet the criteria above only at a bargain price, and not when they are already being traded at their historical highs. Such opportunities keep coming up every few months as stock markets are affected quite a lot by emotions rather than facts. As a result, they zoom up like rockets, but crash like meteors. It is at the bearish worst of the markets that you can find best bargains. Warren Buffett himself likes the fact that the markets shake up a bit every now and then.
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