Legendary investor Warren Buffett has a lot to say about choosing shares. The reason I, along with millions of others, listen is because of Buffett’s stellar track record.
Thinking about the coming year, there are a few of Buffett’s investment habits I plan to keep applying to my investing. Here are five of them.
Stick to what I know
Buffett emphasises the value of staying inside one’s circle of competence. That means focussing on possible investments in companies and industries one understands. That may sound obvious. But it can be tempting to buy shares in companies that seem to be growing fast but about which one’s knowledge is limited. Buffett firmly avoids that temptation. I will be trying to do the same.
Considering competitive advantage
Warren Buffett has a concept that he calls a “moat”. That is another way of talking about competitive advantage – whatever a company has which can keep its potential competitors at bay.
A business moat can come from a variety of sources. It might be a proprietary product as at Coca-Cola, entrenched distribution networks that are hard to replicate as at National Grid or an entrenched customer ecosystem as at Apple. But whatever it is, Buffett sees such a moat as an important source of a company’s pricing power. That is what enables a company to support its profit margins on an ongoing basis.
Kicking the tyres
Buffett often invests in businesses of which he has some personal experience. From Kraft Heinz to American Express, Buffett clearly gets to know some businesses as a customer and decides that they have investment potential for him too.
It’s not always possible to do that. For example, I would consider buying shares in Victrex but will never be a customer of its industrial polymers. But if I was considering investing in a company like B&M or Wetherspoon, for example, I would take time to use the service as a customer first. I wouldn’t base my investment decision on that alone. But it would help me add additional perspective to the information I could gain from a company’s financial reports.
Warren Buffett doesn’t speculate
Buffett is very much an investor not a speculator. He doesn’t try to make money by moving in and out of companies on a short-term basis. Instead, he tries to buy companies whose long-term prospects he likes, at an attractive price.
I try to adopt the same approach. Buffett has said his preferred holding time for shares is “forever”. Whether or not I hold my shares forever, I do think it is useful when buying them to consider shares as long-term investments. If I am already thinking about when to sell a share at the time of buying it, I may not be sufficiently persuaded for it to merit a place in my portfolio.
The importance of diversification
In his long career, Warren Buffett has bought some excellent stocks. But no matter how good he thinks a share may be, he always makes sure to hold a portfolio diversified across different companies and business areas.
That helps reduce his risk in case a company runs into unexpected problems. That’s an important risk management principle I also will continue to apply to my portfolio in 2022.