Warren Buffett has decades more experience investing in the stock market than I do. Therefore, with some spare funds, I want to follow his advice. Here are three solid points that I’m taking on board with my £1,000 right now.
Knowing what I’m buying
A great quote from Buffett was to “never invest in a business that you cannot understand”. To begin with, I might think this is odd, as most FTSE 100 companies are straightforward enough to understand. Yet on further research, this isn’t always the case. It’s more to do with understanding where revenue comes from, what profit margins the business works with and how sensitive consumer demand is.
For example, I might have considered investing in Ocado, arguing that it’s just an online grocer. Yet by delving further I would have found out that the business also has ops with huge future potential — its distribution and robotics arms.
So when investing right now, I need to take this advice in two ways. Firstly, not to rush into buying a stock before I’ve done my homework. Secondly, if after I’ve done my homework I still don’t really understand the business, it’s probably best I put it to one side.
Avoiding overpriced companies
Secondly, I want to apply the advice from Warren Buffett when he said that “a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”
This stresses the importance of buying stocks that are undervalued or at a fair value. One metric I can use for this is to look at the price-to-earnings (P/E) ratio. For example, in the FTSE 100 at the moment, Royal Mail has a P/E ratio of just under 7. I think this is a great company at a low price, and helps me to avoid the pitfall Buffett was referring to.
Taking on Warren Buffett’s long-term mantra
Finally, there’s much I can learn from this comment that “calling someone who trades actively in the market an investor is like calling someone who repeatedly engages in one-night stands a romantic.”
What Warren Buffett was referring to here is the value of being invested for the long term. When looking for options with my £1,000, I don’t want to buy a stock with the mindset of short-term gains. If it does move higher, great, but I want to have the mindset of holding it for a long time.
One of the main reasons for this is that undertaking many trades within my account costs money in transaction fees. It’s expensive to keep getting in and out of the market. Another key reason for wanting to avoid this is that it’s very hard to perfectly time the market. I could be left sitting in cash waiting for a dip to buy that simply never comes.