The success of Warren Buffett in selecting high-quality companies has been highly impressive. He’s become one of the richest people on earth simply through buying top businesses while they trade at low prices. As such, his success could be followed by any investor. Certainly, they may not end up becoming a billionaire as per Buffett, but they may be able to retire early and improve their long-term financial situation.
Therefore, investing your spare capital in shares could be a better idea than playing the lottery. It could offer a much higher chance of enjoying financial freedom in the long run.
As mentioned, Buffett has built his career on identifying high-quality businesses and buying them at low prices. One of the reasons he is able to achieve this goal is he has a large amount of patience. Buffett is willing to wait many years for a company’s shares to reach a price which he feels affords him a margin of safety versus their intrinsic value. In doing so, he improves his chances of making a high return, while also reducing the risk of loss through buying at a lower price.
Buffett’s ability to identify the best businesses is centred on his consideration of a company’s economic moat. He seeks out stocks that have a clear competitive advantage versus their peers. This may, for example, take the form of a cost advantage or brand loyalty which means a company’s performance is stronger than the wider industry throughout a range of operating conditions. Over time, this can lead to a stronger market position, as well as higher profitability.
Of course, Buffett isn’t immune from making mistakes. All investors sometimes buy companies that turn out to be major disappointments. For example, their economic moat may prove to be narrower than expected, while difficult operating conditions may cause their financial performance to be relatively subdued.
Many investors will hold on to companies that have fallen in value – even if there has been a material change in their appeal from an investment perspective. In such a situation, however, Buffett seeks to cut his losses as quickly as possible. This has meant he’s crystallised paper losses in the past to avoid further losses. However, in doing so, he’s also been able to use his capital more effectively elsewhere, which has led to a better overall performance in the long run.
Ignoring other investors
Clearly, some stocks require time to produce market-beating returns. Therefore, unless the investment appeal of a business has deteriorated, Buffett holds on to stocks even if other investors become less positive about their prospects.
This ability to ignore other investors and make his own mind up about specific stocks means Buffett adopts a contrarian attitude. This allows him to ‘buy low’ and ‘sell high’, which could prove to be a simple and effective means of boosting your returns in the long run.
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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.