BUFFETTS BOOKS ACADEMY: INTERMEDIATE COURSE

LESSON 17: WARREN BUFFETT’S INVESTING RULES

LESSON OBJECTIVES

Learn about Warren Buffett‘s four rules for investing in stocks.

LESSON SUMMARY

This video simply outlines that Warren Buffett has 4 rules to investing. Each of the following rules must be met before investing in a stock. To know more, listen to our podcast discussion on Warren Buffett’s Rules to Stock Investing.

BUFFETT’S 1ST RULE: VIGILANT LEADERSHIP

Find a stock/business that has great management. This goes without saying, but leadership has a compounding impact on a business. Without selecting a great manager, the company will likely suffer over time. We have made an entire video to help you find and select a great CEO. That video is found in Course 2, Lesson 18.

BUFFETT’S 2ND RULE: LONG-TERM PROSPECTS

Next, Buffett tries to find a business/stock he can own forever. Now that might sound counter-intuitive to many day traders, but the purpose is very simple. A stock is nothing more than owning a business. Think of a stock like a mini-business. Owning 1 share is no different than owning every share because each share is proportional. As a result, you wouldn’t want to buy a business on main street, only to sell it to another person the next day. That doesn’t make any sense. Even if you were able to make a quick profit, you’ll pay enormous capital gains for the sale. Investors who don’t understand the essence of what a stock is – a real business – have a tendency to trade from day to day. Warren Buffett tries to buy companies he can hold forever because he doesn’t want to pay capital gains tax – not to mention he wants to collect all the profits the business is making.

BUFFETT’S 3RD RULE: STABLE & UNDERSTAND

Buffett tries to find stocks that are stable and understandable. By implementing this rule, Buffett can generally assess the value of a stock because he can somewhat predict their cash flow and earnings power. For example, if you were going to buy a company on Main Street, would you consider buying a company that made un-predictable profits, or would you find the company that generally produces similar results from month to month? Seems like a simple question when you look at it from that perspective. When a company makes similar profits from month to month, you can assess how much money it will make in the long-run, and properly assess a price or value. This is why Buffett tries to find businesses that are stable and predictable.

BUFFETT’S 4TH RULE: INTRINSIC VALUE CALCULATION

You guessed it, Buffett determines a price that he thinks the stock is worth. Think about it like this; would you go and buy a business on Main Street without determining a value that you thought it was worth? Sounds like a crazy idea – right? Well, every time a person purchases a stock on the stock market without determining a value for what THEY think it’s worth, they’re doing exactly that. Buying a business with no expectation for it’s value. In Course 3, lesson 35, we introduce the student to a method for determining the intrinsic value of a stock. We use a discount cash flow calculator – like Buffett. If you want to check it out (because you probably don’t believe it’s free) please do. With that said, we highly recommend you don’t start here. There are many other things you need to learn first before having fun with that calculator!