I was lucky enough to have a number of positive influences before I started investing. One of the first was discovering Lord Lee’s story of becoming an ISA millionaire. It inspired me to set this as my own investing goal. But it wasn’t the only influence I had, because I also discovered Warren Buffett early on in my journey too.
So now, I aim to become an ISA millionaire by using Warren Buffett’s investing philosophy. Here’s what I’m doing.
Warren Buffett’s baseball analogy
The first Warren Buffett idea I use is from baseball. I don’t watch the sport myself, but all I need to know is ‘three strikes and you’re out’. When a batsman misses three pitches, they’re out. But it doesn’t quite work like this when investing. Warren Buffett explains it best: “The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot.”
What he means by this is that an investor doesn’t have to be an expert on every company or sector. I don’t only get three pitches (or companies) to choose from, but every publicly listed company.
Warren Buffett also described this as investing in your circle of competence in Berkshire Hathaway’s annual shareholder letter in 1996. It doesn’t matter how big the circle is – or area of expertise – but knowing my boundaries is key.
Today, I buy companies that I understand. I also don’t stress when other investments are performing well, particularly if they aren’t in my circle of competence. I have many options to choose from, and can wait for the right pitch.
Buying quality companies
The next strategy I use is again best described in the words of Warren Buffett himself: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
There are many ways to define a wonderful company. Usually though, it depends on the returns the business can generate on the capital it uses. One way to calculate this is return on capital. This is the profit a business makes divided by the debt and equity capital it used to generate the profit.
If a business achieves a 20% return on capital, and is able to reinvest its profits at that same return, then over time, the company will generate wonderful returns for investors. Warren Buffett means it’s far better to pay a fair price for a business like this, rather than pay a wonderful price for a business that generates far lower returns on its capital.
So now, I bias my own portfolio towards companies with high returns on capital, but I make sure I pay a fair price.
Patience is key
There’s no quick route to becoming an ISA millionaire, so patience is key. This is what Buffett said about the companies he buys: “Our favourite holding period is forever.” I think this is the most important piece of advice I’ve taken from him.
I look to buy wonderful companies, and let them compound over long periods. Sometimes share prices are volatile, but if I understand the business and nothing has changed, I can carry on holding the shares.
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Dan Appleby has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.