What Warren Buffett Says Most People Do Wrong When Buying Stocks and How To Fix It
Written by
Jordan Rosenfeld
Edited by
Molly Sullivan
Commitment to Our Readers
GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.
20 Years
Helping You Live Richer
Reviewed
by Experts
Trusted by
Millions of Readers
Berkshire Hathaway chairperson Warren Buffett didn’t earn his billions overnight — he adopted an investing strategy that slowly and steadily built him a fortune.
One of the keys to Buffett’s success is buying stocks, and he has said that you don’t need to be a genius to do so; you just need to know how to buy them. He asserts that most people buy stocks incorrectly, by hoping they’ll go up in price “tomorrow.”
Instead, he said, you should be looking 10 to 20 years down the road at solid companies. Business experts explained his strategy, and how you can fix this “mistake” of buying stocks incorrectly.
Look For Economic Moats
“Warren Buffett has often used imagery recalling the Middle Ages, stating that he wants to invest in businesses with economic castles protected by unbreachable moats,” according to Robert R. Johnson, PhD, CFA and a professor of finance at the Heider College of Business at Creighton University
Johnson said this is a way of describing a firm’s competitive advantage and assessing the durability of that advantage. In other words, only invest in a firm with a sustainable business model with a solid “economic moat.”
Better yet, Johnson said, invest in companies with “multiple moats.” He pointed to Apple as an example of such a stock.
Apple is “the consummate firm” Johnson said, because its value increases as more people use its products, which is known as “the network effect.” He added, “Apple excels with respect to the network effect as the firm has created a technological ecosystem with iPhones, iPads, Macs and Apple watches. The value of all of these devices increases as more apps become available. Additionally, Apple Pay, the Apple Card and Apple TV expand the firm’s influence and increase cash flows.”
Invest In a Company’s Value Long Term
Scott Ritchie, an investing expert with Stoculator, said that a great way to approach investing in stocks is to value the company behind the stock, like Buffett does.
“Most retail investors view stocks as these financial instruments that they could buy at a price and then sell for a higher price, overlooking the fact that the stock is a representation of their ownership in an actual operating business,” Ritchie said.
To find companies like Buffett does, Ritchie said you need to forget the financial instrument that you use to buy a small piece of these companies, ignore all the price bidding and market noise and start looking at the company as a business.
For example, he said, say you were offered a chance to buy your local laundromat or coffee shop, but not allowed to sell it for the next 30 years. “You would have to evaluate that local business as a business that operates to generate money. The first questions that might come to your mind are how much money is the business currently making each month? How much would it cost to keep it running? Does the business owe anyone money that needs to get repaid? “
Get Financially Literate
In order to answer those questions, Ritchie said, “you need to have basic knowledge in finance and how businesses are managed, in addition to some knowledge about the industries you are considering buying into.” Fortunately, these are basic-level knowledge, and you wouldn’t need to go to college to reach this level.
Pick an Industry
Another way to get better at buying stocks is to focus on a specific industry at first, particularly one where you have some knowledge or background. However, Ritchie said, “Keep in mind that across all the industries, the fundamentals remain the same: how to keep generating more revenue while keeping the costs as low as possible.”
Assess the Deal
After you establish that the business is healthy and determine how much it’s worth, you’d want to check the price tag, Ritchie said. “Is it selling at a discount? Are you getting it for a steal? You don’t drive all the way to the outlets or delay your shopping plans till Black Friday only to end up paying the original value.
“Buying a business at a discount not only gives you a head start, but it also provides you a margin of safety that would protect you if you’ve made mistakes in your calculations or faced some bad luck with negative external factors.”
Once you have rewired your brain to look at companies and businesses instead of stocks that go up and down, it will be more clear that these stocks are a financial instrument that you use to gain ownership in these companies in a quick and simple way.
Leadership Is Key
A company’s leadership is also important, according to Adam Koprucki, founder of Real World Investor. “Read about the CEO and management team’s track record to see if they have a clear vision and proven success.”
Diversify
Lastly, don’t forget to diversify, Koprucki insisted. “Index funds are a good way to balance out individual stock picks. It’s all about patience, research and finding businesses you actually believe in.”
More From GOBankingRates
