When is the best time to follow Warren Buffett’s investing rules? I’d say always. But right now I think the time is especially perfect. We face a bewildering mix of companies still suffering from pandemic effects and a hammered UK economy. But there are strong signs of renewed growth.
I reckon there are many great investment opportunities out there. But also an enhanced risk of getting it wrong and losing money. Just look at all those share prices that climbed in early 2021 on premature recovery hopes, but have since fallen back.
Never lose money
I inevitably turn to Buffett’s famous first two rules of investing: “Rule number 1: Never lose money. Rule number 2: Don’t forget rule number 1.”
We all inevitably lose money at times in our investing career. Buffett has done it himself many times. But what these rules are really about is priorities. Yes, there are profit opportunities around right now, but we should prioritise capital preservation ahead of growth ambitions.
I think many who bought a lot of those recovery stocks early in 2021 made that mistake. Instead of first looking for shares that might be set to soar, these rules suggest we should first find shares that are least likely to lose us money.
Buy wonderful companies
That brings me to my next Buffett rule: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.“
If a stock has fallen 50%, it’s tempting to think that when it recovers it will be back to its old valuation. But, along with that 50% fall, there are often underlying structural and financial changes.
Take International Consolidated Airlines. Even if it gets back to pre-Covid profits, those profits will have to service far more debt than previously. And the company is still facing a very uncertain few years, which I think makes it worth less now.
But at the height of its early 2021 recovery, on an enterprise valuation (which accounts for debt), IAG was similarly valued to before the slump. It might have looked like a wonderful share price at the time. But in 2021, I do not rate IAG as a wonderful company.
Buffett understands
One of my favourite Buffett quotes is: “Invest in what you understand.” I think it’s critically important to be able to separate a company from its share price. I try hard to not think I’m buying shares, but buying companies. And I’m not specifically targeting share price rises, I’m after the profits that my companies can generate for me, however they arrive.
During the pandemic crisis, I’ve had a number of people ask me what I think about a particular share price. It’s typically one that’s crashed, and the questioner seems to think there’s a killing to be made when it recovers. I usually respond by asking what the company does, and what its financial state is like. They usually have no idea.
There are plenty more, but the various aspects of Buffett’s investing philosophy all point to minimising risk. And I think that’s especially important in today’s uncertain times.
