I’ve been following Warren Buffett now for a while and I really believe in the investors philosophy and principals, after reading The New Buffettology I feel like I’ve matured as a investor and it’s probably the most effective four hours I spend listening to the book on Audible. The advice that Warren Buffett would give to new investors is to be patient and not rush into trading stocks you know little about. One of the mistakes that I made was to invest in stocks by just looking at technical analysis, trends, rumors and recommendations, some of my trades performed well but most of them made me lose money and helped to get me poor quicker.
Warren Buffett Advice For New Investors
Warren Buffett is a contarian investor who looks for value when investing in the stock market, he is not looking for short term gains, he is prepared to buy into a company that he really believes in and leave his money there are long as the principals and philosophy of the company is congruent with his criterion. The key to Warren Buffett’s success has been looking out for value and finding companies that have a durable competitive advantage. Companies and stocks which have a durable competitive advantage have a strong brand presence like Nike or Coca Cola, these stocks are not price competitive and people are prepared to pay higher premiums for the service like H&R Block. These stocks are also durable which means that they can remain in the number one position without spending too much of their retained profits.
Finding Stocks With Durable Competitive Advantage
There are ten key financial indicators that you can use to determine whether a stock has a durable competitive advantage. You can use sites like MSN money to find the financial history for the last ten years so that you can check the fundamentals of the company, at the end of this article I will give 5 companies that Warren Buffett holds large positions in with links to the financial information.
The first metric to look at is Price Earnings Ration, this is simply price divided by earnings per share. The most important point to remember is to look at the PE Ratio for the last 10 years, it’s advisable to buy when the PE ratio is low and sell when the PE ratio is high. The best way to understand PE ratio is how much would you have to pay to get a dollars earnings from the stock? Some stocks trade at a PE Ratio of 60 which means that you would have to pay $60 to get $1 in earnings, while some stocks trade at PE ratios of 10 (Apple is trading at PE Ratio 10 at the moment 11/10/2013). The lower the PE Ratio the more valuable the company.
Return of Equity & Return of Capital
Another factor that you need to consider is the return you could expect to get from your investment to see if it’s worth investing. If a stock has $100 in assets and $50 in liabilities and earns $10 in profits then the Return of Equity is $10/($100-$50) which is 20%, the Return on Capital is $10/$100 which is 10%. Warren Buffett looks for companies which have a ROE and ROC which are both over 12%, the reason for the 12% is because this is the stock market average for the last 100 years and he always looks to beat the market.
Long Term Debt
Nobody likes a company with debt and Warren Buffett is no different, if the value investor finds a company he likes but it holds long term debt he checks to see if the debt is rising or falling, if its falling then that’s a positive. He then checks to see how long it could take to wipe clean the debt from earnings, if a stock like Coca Cola had $100 billion in long term debt and earns a profit of $33 billion then it can clean the slate within 3 years, the quicker the company can pay of it’s debt the more desirable it become because it can then use the profit to pay dividends to shareholders.
Inflation & Price Competitive Stocks
Price competitive companies are those which compete with one another in terms of price, these companies suffer the effects of inflation, this is because when price of raw material rises the costs rise and companies can’t raise prices because they are in competition. Avoid price competitive stocks if you want to make a real profit ahead of inflation. You should be looking at companies that can raise prices in line with inflation without losing customers, companies like Hershey (HSY), Kraft (KRFT), and Yum Brands (YUM) are all examples of companies that can keep ahead of inflation.
Powerful Labor Forces & Trade Unions
You should also be aware of companies which are prone to disruptions from labor forces, airline companies, investment banking firms and car makers are at the mercy of their staff, if a group or pilots or car makers strike or top investment bankers leave for the competition this can really hit profit hard. Look for companies where staff can be replaced very easily, companies would include McDonald (MCD) and Taco Bells (YUM).
Active Stock Buy Back Programs
Look for companies which actively buy their stock back as this makes existing shareholders richer, consider a partnership which has three partners with equal holdings, they will all receive one third of the profits, if two of the partners buy out the remaining partner their share and profits will increase. You can check on MSN money whether companies are buying back stock by checking the outstanding stock every year for 10 year. What you are looking for is strong buy-backs which makes the company really valuable.
When To Buy Value Shares and When to Sell
The best way to make money investing in value stocks is to keep a watch list of companies which have a price competitive advantage, the best time to buy is when the stock market is in a bear market or has crashed or when the stock is suffering from a calamity that can easily be overturned. The best time to sell is when the Stock is trading at high PE Ratios which means they are overvalued making it the perfect time to sell.
Stocks That Warren Buffett is Investing in 2013
Here are some stocks with direct links to MSN Money which shows the financial history for the last 10 years. If you can use these financial indicators to screen for the best stocks and keep them in a watch list ready to buy whenever the market takes a turn for the worst.
Johnson & Johnson