Case Study: Warren Buffett, part 2

Case Study: Warren Buffett, part 2

Simply put, here is the distilled wisdom of making money on the stock market in long term investment:

See stocks as businesses

Many people buy stocks and see them as pieces of paper that give dividends or capital appreciation. Yes, that is actually what stocks are, but to make money in the stock market, Warren Buffett suggests a different approach. Why not see stocks as businesses, or part of businesses instead?

Every stock certificate is linked to a company, and there are many considerations in fundamental analysis that can show you the various parts of a company. Stocks are indeed linked to businesses, and the prices of the pieces of paper stem from the businesses. If you believe this paradigm, then the stocks yield money when the businesses are healthy.

I would say: is there a market for the good? Is the company doing well now? Is the company under good management, or are the people in control known for not being trustworthy? Simply put: see the stocks as linked to businesses, and apply fundamental analysis. Warren Buffett reads a lot of annual reports a year and therefore he makes a lot of money when the decisions turn out right, based on fundamental analysis.

Use market fluctuations to your own personal advantage to make money in the stock market

Warren Buffett and Ben Graham often talk about Mr Market. This is an allegory.

A man called Mr Market turns up every day and quotes prices to you. He is basically a price quoter and does nothing but quote prices to you, and you are the one who must decide whether to buy or to sell. Market fluctuations therefore help you if you can sell to Mr Market when he quotes high prices and buy from him when he quotes low prices. It is that simple. Mr Market is occasionally optimistic and occasionally pessimistic, but as long as you buy and sell at the right prices, there is no need to worry because you will make money. Why? Simply because you are able to profit from folly and profit from market fluctuations, and you did not join them.

The importance of margin of safety and not cutting things close

Another metaphor here is wise: Warren Buffett once mentioned a bridge and suggested that you do not drive heavy trucks over a bridge meant for heavy loads, but rather, you drive small trucks that are light over a bridge that can bear more load. This is the idea of margin of safety.

Another way of looking at it would be: it's better to buy a dollar for 40 cents than it is to buy a dollar for 70 cents. You don't cut things close. This enables you to make money from the difference.

What do we learn from the bridge metaphor and from the dollar analogy? We learn the value approach. Just as we do not want to fall over a precipice by driving a heavy truck over a bridge, and just as we want to make money by buying dollars cheap, we should do the same for stock investments. Do not cut things close.

Use your common sense - or Warren Buffett's common sense

Last but not least, use common sense.

This may prove harder than the more technical aspects of value investment, like margin of safety and fundamental analysis, and the other elements of Warren Buffett's system that I mentioned already. The reason is that this needs to develop via experience. Diversification may not be a good idea if you know what you are doing, but if you don't know, then diversification might save you. That kind of common sense is sometimes counterintuitive and may take some time to acquire.

In addition, Warren Buffett does not always make the right decisions - and in some cases he even lost money. For that he has a good joke, and one we can learn from:

There are two rules of investment. The first is never lose money. And the second rule is, never forget the first!

More to come on other case studies and other rich men here on my ideas site on how to make money and how to become rich. Cheers!


NOTE/ DISCLAIMER/ SMALL MESSAGE: This is an ideas on how to become rich blog and should cover every possible idea on how to make money and how to become rich, not just in the financial market or in the stock market. Yet there is a focus on the stock market, among other financial devices and financial markets. At the same time, I write a lot about Warren Buffett and will continue to do so because he is one of the best investors in the world and the ideas that he preaches and practises have been proven to beat the market.

Not everyone will agree with what Warren Buffett teaches and what I write. This is true, natural and only to be expected - after all, opinions and ideas always differ. At the very least, you learn from me one major idea on how to get rich, and in the way and manner of your choosing - you can choose someone who is very rich and then make a mentor of him, learning his skills and ideas and concepts that have enabled him to make money, be it in investment, in a job, or in banking, or in real estate and the like. That means that if Warren Buffett and value investing is not your cup of tea and these don't interest you, the other case studies here on my ideas site might help you. Cheers!

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