Warren Buffett reckons a low-cost index tracker is the best option for most investors. However, if you’re reading this article, you probably prefer picking individual stocks or are thinking of starting in 2020.
Buffett has slaughtered the market for decades, and I have three tips from the Sage of Omaha that could help your stock picking and investment returns in 2020 and beyond.
Circle of competence
According to Buffett, “what an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. “
In the course of our lives, we all acquire valuable knowledge about certain areas of the world. Most of us will have a general understanding of the economics of a shop, a pub, a restaurant, and so on. With some accounting knowledge and study, we’d be competent to evaluate companies operating in such sectors, as well as companies operating in any areas where experience or study happen to have given us a deeper specialised knowledge.
Honestly defining your circle of competence is a good start to picking stocks. As Buffett has said, mistakes are most often made – and money lost – when straying outside it.
Keep it simple
Buffett reckons the best investment ideas are simple and can usually be explained in a single paragraph. He’s said:“Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count.” And, to switch sports: “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”
In other words, if you correctly evaluate a business with easy-to-understand and enduring key features, the payoff is just the same as if you successfully analyse a far more complex alternative. Furthermore, the more complex it is to evaluate the intrinsic value of a business, the higher the risk of making a mistake – and losing money.
Wait for your pitch
You may have identified a shortlist of companies within your circle of competence, with what you’ve assessed as easy-to-understand and enduring key features, and you’d just love to invest in them. But you can still make a mistake – and lose money – by overpaying for them. If a stock isn’t trading at a discount to your assessment of its intrinsic value, have the patience to wait for an opportunity when it is.
As Buffett has said (a baseball analogy this time!): “The stock market is a no-called-strike game. You don’t have to swing at everything – you can wait for your pitch.”
In summary, by sticking within your circle of competence, focusing on companies where you’re confident in your evaluation of intrinsic value, and buying the stock when it’s at a discount to that value, you’ll be following key principles that have made Buffett such a successful investor.
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G A Chester 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.