As I write, there are 77 companies on the London Stock Exchange whose shares have risen by at least 100% since the start of the year. In my experience, volatile conditions like this don’t always end well. To make sure my share portfolio is in good shape to face a possible slump, I’ve been following Warren Buffett’s tips for investors.
Billionaire Buffett is widely seen as one of the world’s most successful investors. His company Berkshire Hathaway has delivered an average yearly gain of about 20% over more than 50 years. My aim is to build a portfolio like Buffett’s, that delivers reliable growth and income for many years. Here’s how I’m doing it.
Not a popularity contest
Buffett is fond of quoting his mentor Ben Graham, who once said that “in the short run, the market is a voting machine, but in the long run it is a weighing machine.”
What he meant was that over short periods, share prices can be influenced by fashions and bubbles. But over longer periods, companies tend to achieve a fair value based on their ability to generate reliable profits.
I think this tip is particularly relevant right now. In my view, we’ve seen a lot of voting in the market this year. One extreme example is loss-making US retailer GameStop, whose share price rose from $39 to $347 in one week in January. It then crashed to $50 over the next two weeks. Right now, GameStop shares have bounced back and are trading at $191. But unless this company delivers a pretty amazing turnaround, I think the stock is still seriously overvalued.
On the other hand, FTSE 100 consumer goods group Unilever has seen its share price move by just 3.5% so far this year. Buffett once tried to buy Unilever, which I see as a quality business. In my view, Unilever’s flat price is an example of Graham’s weighing machine in action.
Don’t be afraid to sell
Buffett also famously said that his number one rule of investing is never to lose money. Of course, like all investors, he’s made some wrong calls over the years. What distinguishes him from some less successful investors is how he handles bad investments.
Here’s what he has to say on this subject: “The most important thing to do if you find yourself in a hole is to stop digging.”
What this Buffett tip means is that investors shouldn’t fall in love with shares. I try to look at the stocks in my portfolio with fresh eyes and ask myself if the investment case is working out in the way I hoped. If it isn’t, then I think about selling.
The best Warren Buffett tip?
I want to wrap up with a quote that I think could be the best Buffett tip of all time: “Only when the tide goes out do you discover who’s been swimming naked.”
In a rising market, it’s fairly easy to make money and look successful. But market conditions aren’t always this good. When conditions get tougher, the market starts to punish companies that are losing money or have too much debt.
That’s why I’m focusing on buying shares in quality businesses with a long record of profitability. I don’t want any sleepless nights next time the market crashes.