Warren Buffett has quite a reputation for achieving staggering returns in the stock market. In fact, since the 1960s, his investment firm Berkshire Hathaway has delivered an average annualised gain of 19.2% — nearly double the stock market average over the same period.
Mimicking these gains is something countless individual and professional investors have tried to achieve. Most have fallen short. But while hitting near-20% returns consistently is exceptionally challenging, it’s not necessary to reach that level in order to build substantial wealth in the long run. And even if following in Buffett’s footsteps only results in an extra 2% above UK indices like the FTSE 250, that can still have a monumental positive impact on wealth.
With that in mind, let’s explore the legendary investor’s most critical tactics that led him to success.
High quality at a good price
In the early days of his investing career, Buffett was focused on what he called ‘cigar butt’ companies. These were businesses on their last legs trading at exceptionally low prices because no one wanted to own a failing business. A lot of these companies often went bankrupt. Yet Buffett still made a profit because he paid less than they were actually worth after liquidation.
Since then, his investing style has changed quite significantly. Today, his focus is primarily on finding wonderful quality rather than a wonderful price. Rather than cigar butts, he’s after top-notch enterprises that will continue to thrive, in his words, “forever”.
In the long term, stock prices are ultimately driven by the underlying business. And even if a company has passed its prime as a growth enterprise, tremendous long-term wealth can still be unlocked if the cash keeps coming and it can still expand and retain its market share.
However, even with quality being the primary focus, Buffett won’t buy unless it’s at a fair price. After all, overpaying for even the best company in the world can still end up as a terrible investment.
Stay within the circle of competence
Companies can be enormously convoluted corporate entities, especially those operating in complex industries that require expert knowledge to properly understand. Every investor has their limits of knowledge. And Buffett actively avoids investing in businesses he can’t wrap his head around.
This approach can leave a lot of money on the table. But it’s a relatively simple strategy to avoid making potentially disastrous mistakes. And while the fear of missing out can make maintaining this discipline challenging, it’s important to remember that the stock market is a vast place with new opportunities emerging every day.
I certainly learned this the hard way when it comes to fashion stocks. After making several seemingly smart investments within this space at the time, the subsequent disastrous performance clearly demonstrated that this industry lies beyond my circle of competence.
That’s why I haven’t touched this industry in five years. Instead, I’ve been allocating my capital to other sectors that I understand far better, like technology and healthcare and achieving significantly better returns in the process.
