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5 investing lessons I learned from Warren Buffett

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Berkshire Hathaway leader Warren Buffett is well-known for amassing  a fortune thanks to his investing and management prowess. But Buffett is also generous in sharing his wisdom, which can be a boon to investors. Here are five investing lessons I’ve learned from Buffett.

Quality is worth paying for

Buffett started with what he calls “cigar butt” investing – buying companies that look cheap and might have just one good puff left in them before they decline. That is a form of value investing and it can be attractive, because buying something for less than it is worth often seems attractive.

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Buffett points out that it is worth paying more to get a quality business that can keep growing profits into the future. That is one reason I like Unilever – no matter what happens in the short term, its broad-based brand portfolio should enable it to prosper for decades to come.

Warren Buffett sticks to what he knows

Buffett missed out on some amazing tech stocks. But he also missed out on lots of terrible ones. That is because he avoided the sector for decades, saying he didn’t understand it. Buffett talks about the value of staying inside one’s area of knowledge. That sounds obvious, but a lot of investors chase hot stocks with no real ability to assess their likely returns.

That is why I avoid lithium stocks like Bacanora – I just don’t feel qualified enough yet to judge the relative merits of different lithium projects. By contrast, I understand the market for domestic gas and feel comfortable picking a company with exposure to it, such as DCC.

Cash generation is the name of the game

If one looks at the businesses in which Buffett invests, a consistent theme is that they tend to be fairly cash generative. That means they often don’t need large amounts of capital, although some Buffett investments like railways are capital intensive. But they throw off huge amounts of cash, which makes them attractive investments.

Free cash flow is a key metric I consider when looking at a stock. It gives a good indication of whether a company is actually getting money in the door. That’s one reason I like highly cash generative businesses like British American Tobacco. It’s important to remember, though, that historic cash generation might not be replicated in future.

Focus on businesses not management

While Warren Buffett praises individual managers, his position is actually not to focus on management quality alone. He suggests investing in businesses that would be successful even if run by idiots. That makes sense to me, because no management lasts forever.

Instead, I like to choose businesses which have fundamental strength I judge likely to endure. For example, Howden Joinery is a well-run business. But even it wasn’t, its network of trade counters gives it a strong commercial position, which I expect to continue. After a recent recovery, though, its share price is less attractive to me than it was.

Buffett cuts his losses

When things turned bad at Tesco several years ago, Buffett didn’t wait to see if they would get better again. Instead, he cut and run – with a big loss. That can be hard to do but as Buffett says, there is rarely only one cockroach in a kitchen.

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christopherruane owns shares of British American Tobacco. The Motley Fool UK owns shares of and has recommended Berkshire Hathaway (B shares). The Motley Fool UK has recommended Howden Joinery Group, Tesco, and Unilever and recommends the following options: short January 2023 $200 puts on Berkshire Hathaway (B shares), short March 2021 $225 calls on Berkshire Hathaway (B shares), and long January 2023 $200 calls on Berkshire Hathaway (B shares). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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