Warren Buffett is worth over $60 billion. He knows a thing or two about investing.
True geniuses tend to make things simpler, not more confusing. Buffett is no exception.
Buffett simplifies investing down to the following:
“All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.”
That doesn’t sound overly complicated – because it isn’t. Click here to see 17 of Warren Buffett’s best quotes analyzed.
Buffett says there are 3 things that make a successful investment:
- Good stocks (strong competitive advantage)
- Good times (low prices)
- Stay with them as long as they remain good investments (let them compound your wealth)
You don’t have to be a genius to follow this plan…
“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ” - Warren Buffett
Warren Buffett’s mentor was Benjamin Graham – the father of value investing. Three of Graham’s ideas greatly impressed Buffett. He went on to say that:
“(He) believes those ideas, 100 years from now, will be regarded as the three cornerstones of sound investing.”
Warren Buffett’s 3 cornerstones of sound investing are:
- Look at stocks as small pieces of a business
- Look at market fluctuations as your friend rather than your enemy
- Margin of safety
This article takes a deeper look into each of these 3 investing cornerstones.
Look At Stocks as Small Pieces of a Business
For many (if not most) individual investors, the stock market is a large virtual casino.
If you pick the right 1, 2, 3, or 4 digit ticker symbol, you could double or triple your money! If you pick the wrong one, you could lose it all.
It’s easy to see why…
Stock quotes are updated in (nearly) real time, giving markets the same frenzied tempo as you see on a spinning roulette wheel in Las Vegas Casino.
You can pull up lists of the top performing stocks every day to see the ‘big winners’ and ‘big losers’
If only you invested in the big winners every day… You’d be a billionaire in no time!
This has led to the prevalence of penny stocks. A stock could be worth $0.01 today, and go to $1.00 tomorrow – giving you 100x returns in a day! Of course, this rarely (if ever) happens. Penny stock sites like to hype up your brain with the (largely false) idea of big returns that are easy to get.
Informed investors know better.
Traders with a gambling mentality trade very frequently. Who stands to gain from rapid trading?
Wall Street firms in general, and discount brokerages in particular.
The truth is that discount brokerages are worth billions because investors trade so frequently. The less you trade, the more money remains in your account (where it belongs) to compound, and the less money goes to financial institutions. Click here to learn more about Wall Street and investing fees.
The less you trade the better your investments will do. This is not conjecture, it was proven by analyzing thousands of individual accounts at a discount brokerage over a period of years.
It can be difficult to get out of the gambler mindset – because gambling is addictive. It’s also one of the most important things you can do to preserve and grow your wealth.
The stock market isn’t a casino – far from it. Rather, the stock market is a place where people with excess capital (investors) go to purchase pieces of businesses.
Thinking of a stock as a small piece of a business dispels the gambler myth about the market.
When you buy a stock (even just 1 share), you are buying fractional ownership of a business.
It’s even easier to remain committed to your stocks when you can actually see or use their products.
That’s because a link between the digital numbers in your investment account and the real world business is established.
This makes it obvious how wrong the idea that the stock market is a giant casino really is.
If you own shares of PepsiCo (PEP), you know you are profiting every time you see someone drinking a Pepsi or eating a bag of Lay’s potato chips.
Similarly, if you own McDonald’s shares (MCD), you benefit every time someone eats at McDonald’s.
While it’s true we don’t get tiny checks every time someone drinks a Pepsi or eats a Big Mac, the real earnings from these purchases do pass through to the business – and the business passes that value along to shareholders in one of two ways:
- If earnings rise, the share price will (eventually) rise
- Through dividends
That’s one of the many reasons I’m such an advocate of Dividend Growth Investing; it creates a link between rising company value and rising dividend income.
When McDonald’s makes more money, it pays a larger dividend. This makes the connection between the business and your investment very clear.
McDonald’s (and every other business) can only pay rising dividends if they make more money every year (or nearly every year).
Dividend growth investing places the emphasis on the business. If a PepsiCo or McDonald’s stops growing, it will be unable to pay rising dividends in a few year – there is no escaping the cold hard reality that dividends come from earnings. To pay increasing dividends, you must have increasing earnings.
To have increasing earnings for decades, a business must have a strong and durable competitive advantage.
Dividend growth investors don’t look to gamble on ‘the next big thing’. Instead, we look for businesses that have the ability to pay increasing dividends.
This puts the investor’s focus right where Warren Buffett says it should be – on the business.
There is a select group of stocks that have paid increasing dividends for 25+ consecutive years in a row. This group is called the Dividend Aristocrats. Click here to see all 50 Dividend Aristocrats.
To be a Dividend Aristocrat a business must have a strong competitive advantage – how else could it pay increasing dividends for 25+ years? It should come as no surprise that the Dividend Aristocrats index has substantially outperformed the market over the last decade.
Source: S&P Dividend Aristocrats Fact Sheet
If investors looked at dividend increases rather than stock prices, investors in general would be far better off.
Stock prices are distractions that can deter you from the goal of investing in great businesses with favorable growth prospects.
It’s important to view stock prices (and market fluctuations) in the correct way.
Loot at Market Fluctuations as Your Friend
Warren Buffett’s second cornerstone of sound investing is to look at market fluctuations as your friend rather than your enemy.
In every other aspect of life, when someone offers you a lower price on something, that is seen as a positive. If you want to buy socks, and they are on sale for 50% off, no one is going to panic and demand to pay full price.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down” - Warren Buffett
The Warren Buffett quote