How to Invest in Stocks like Warren Buffett

Everyone knows that Warren Buffett, Chairman and CEO of Berkshire Hathaway, is the greatest investor alive and throughout history. In the year 2008, his wealth amassed to 60 billion dollars, beating Bill Gates and Carlos Slim as the richest person alive. However, he’s pledged to give 98% of his wealth away to the Bill and Melinda Gates Foundation and started giving it little by little since then. In 2012 he is no longer the world’s richest person, but is still 3^rd which is very impressive after giving billions away. Warren Buffett started working when he was 9 years old and started his first business (pinball) when he was in high school. He bought a farm before going to college and got his BS in Business and MS in Economics. He was already investing while in college and in fact, bought his first stock when he was 9 years old. After learning from Ben Graham and investing for over 60 years in his life, he is now an investing legend/guru. We can learn a lot from him.

I have read many books written about him, read his annual letters, and watched his videos. This is a summary of how you can invest like him. It’s a simple guide that any investor can follow.

1. Don’t buy pieces of paper

Warren Buffett’s first advice is to not look at a stock as a piece of paper, but that you are a part owner in a business. This is what he first learned from Benjamin Graham in his book “Security Analysis” (long version) and “The Intelligent Investor” (short version). This is the one thing people don’t understand. They view a stock as just some piece of paper (electronic piece of paper nowadays) to be traded back and forth. However, you should view it as a business, and should only buy it if you wouldn’t mind buying the entire business itself if you could. This is the most important lesson, so don’t forget.

2. Find wonderful businesses

So the first lesson is to see a stock as a business, which of course you should find wonderful businesses to invest in. I’d say you should find the best or top businesses in each sector or industry. Do not settle for a fair or bad business/company. As Warren Buffett says "It's farbetter to buy awonderful company at afair price than afair company at awonderful price." An example of a good company would be Apple or Coca Cola, a fair one would be Target or Kroger, and a bad one would be Fannie Mae or Freddy Mac.

3. Determine its intrinsic value

After spotting out the best companies you can find in each sector or industry, it’s time to find out how much it’s worth. Finding its intrinsic value is different than looking at its book value (what its assets are worth) or its market cap/value (the average of everyone thinks its worth). This part is the trickiest one and even Warren Buffett himself could not explain it (or maybe he doesn’t want to, but he does mention it). To evaluate how much a company is worth, you must see how much cash it can earn as far as you can see in the future. The more competitive edge (a moat is what Warren Buffett calls it) it has over its competitors the longer it will be able to continue generating that cash flow. What I suggest you look at are, but not limited to: the financial statements, its products, how strong its brand is, the business model, management, and its moat/competitive advantage.

4. Buy the stock well below its intrinsic value

Once you find a wonderful company and find its intrinsic value, it’s time to see whether to invest in it or not. Let’s say if you think Apple, Inc. (ticker: AAPL) is worth $400 billion, but its current market cap is only $376 billion. That is buying at 94% (376 billion/400 billion) of its intrinsic value and Warren Buffett usually wouldn’t buy it at this price (Warren Buffett doesn’t even like tech stocks, but that’s another story). However, let’s say you think PetroChina Co Ltd. (ticker: PTR) is worth $350 billion and its current market cap is $232 billion. That is buying it at 66% (232 billion/350 billion) of its intrinsic value and Warren Buffett would probably buy it because he usually buys a wonderful company at 75% or less of its intrinsic value and buys a good company at 50% or less of its intrinsic value.

5. Hold it for the long-term (10+ years), preferably forever

Here’s the last advice from the Legendary Warren Buffett, the Oracle of Omaha, “Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.” This is very important because the more you trade the more fees and taxes you pay including: commissions, spread fee, and capital gains tax. The more you trade also means the less time you have studied on a stock/business and the higher chance it is to make a mistake. The longer you hold it the more time you will have studied a stock/business and the less commissions, spread fee, and capital gains tax you pay. Also, if you are going to hold it for 10+ years, then I suggest you buy most stocks which pay some dividend, but not very high dividend though as it grows a lot slower. Then just sit on it, relax, and enjoy the dividend quarterly. However, there are times when Warren Buffett does sell his stocks and I identified 2 of them. Reason #1 is when he finds a MUCH better opportunity (stock/business) and doesn’t have the capital to buy that one, so he sells his worst stock out of his wonderful stocks (sometimes he sells all of the stocks and sometimes partially) in order to fund his new and better investment. Reason #2 is when his stock drops from being a wonderful company to a fair or worse company (my best to worst scale: wonderful->good->fair->bad->terrible). This is when I suggest you to sell your stock even at a loss, but you MUST be beyond the shadow of a doubt that this company’s stocks that you’re holding is either fair or worse now. You cannot guess or be influenced by the market movement to sell your stocks. This must have objective data/facts and reasoning. Reason #1 is usually a lot more likely than reason #2 to occur. Reason #2 usually only happens when a new company suddenly improves so much that its stock surpass your stock that you’re holding. An example would be like Google (GOOG) overpowering Yahoo (YHOO) or Apple (AAPL) surpassing Microsoft (MSFT). If a stock becomes way overvalued, then you may sell half of it.