The price of gold has surged in recent weeks. Following this performance, some investors may be considering buying the yellow metal ahead of further gains. However, investing in gold does not guarantee returns. As such, I’d rather make a million following Warren Buffett’s investment strategy.
Invest like Warren Buffett
Warren Buffett’s investment strategy is based around a simple idea. He wants to buy cheap stocks. The method he uses to evaluate whether or not a company is cheap is to look at its cash flows.
This simple analysis allows the billionaire to understand how productive a business is and what sort of returns it can generate for shareholders.
It’s impossible to do the same with gold. Because gold does not produce any cash flow, its price is determined by supply and demand. That means it is impossible to tell what the price of gold will do over the next five or 10 years.
On the other hand, it is possible to roughly estimate the sort of returns a stock could generate over the same time frame using Warren Buffett’s investment strategy.
The shares of a company that earns a return of 10% on its assets every year, for example, could produce annual returns of as much as 10%.
The road to a million
Therefore, it may be much easier to make a million using Warren Buffett’s approach rather than trying to guess what the future holds for the price of gold.
Another advantage of investing in stocks rather than gold is the fact that companies can return cash to investors. For example, the FTSE 100 currently supports a dividend yield of 4.3%. On the other hand, investors buying gold today will not receive any income. It may cost money to store the precious metal.
Warren Buffett has made billions by using this approach over the years. By analysing the cash flows and profitability of companies, he’s been able to pick the most profitable ones, and this has helped him outperform the market.
Investors may be able to replicate this approach by focusing on high-quality stocks that earn attractive profit margins.
The bottom line
It is impossible to tell what will happen to the gold price or stock prices in the near term. However, over the long run, stock prices have outperformed gold because they reflect the performance of the underlying business. Gold prices only reflect market sentiment towards the precious metal.
Warren Buffett has been able to use this discrepancy to grow his wealth significantly over the past few decades. There’s no reason why the average investor cannot replicate his success in the market by focusing on stocks rather than gold.
There’s no guarantee equity prices will outperform gold in the near term, but over the long run, there is plenty of evidence that supports the conclusion that stocks are by far the better investment.
Rupert Hargreaves owns no share 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.