How To Understand Warren Buffett's Money Investment Principles

In 1965, an investor took control of a ten thousand dollar investment in Berkshire Hathaway. The same investment grew and was worth thirty million dollars in 2005. That investor is Warren Buffett.

Warren Buffett is considered a genius in money investment. His investment principles are the most successful in the field. In fact, the same principles have made him able to compound his investments for over 20% per annum for more than forty years. His capability to see a company's overall potential and sees how much money the company can make as a business.

Warren Buffett achieved his success by applying his six money investment principles. He keeps it as simple as possible by waiting patiently and investing on companies other investors would think of as cheap. He makes his move only after seeing that the market moves in his favor so he avoids losses.

His money investment principles are actually questions that he asks himself before he invests on a company and these are:

  1. Has this company performed well consistently? Warren Buffett keeps a close eye on a company's Return on Equity (ROE). The ROE shows how much the investors are earning from their shares in the company. He uses the company's ROE as a gauge in assessing if the company has done well compared to others in the same league. ROE is computed with the following formula: = Net Income / Shareholder's Equity. A company that is doing well should have an average ROE between 15-17% at a five year period.
  2. Does the company have excess debt compared to others in the same league? Warren Buffett prefers a company that has less debt so that the profits earned will obviously come from shareholders' equity and not from the loaned money. He calculates debt/equity ratio with the following formula: = Total Liabilities/Shareholders' Equity. The higher the ratio, the higher the debt is. The best debt/equity ratio should be less than 80%.
  3. Are the company's profit margins high and are they increasing? Warren Buffett computes a company's average profit margin by dividing the net income by the net sales. The company should not only have less debt but should also be able to consistently increase the profit margin. The profit margin for the last five years is looked at. It is in increasing, it only shows that the company is doing well at managing the resources and lessening the expenses.
  4. How long has the company been in public? The company should at least be one that has been around for more than ten years. Longevity shows how a company withstands the test of time and that is important for Warren Buffett.
  5. Will commodity pricing affect the company? Warren Buffett only invests in companies that are able to offer something new and unique. He believes in economic moat or competitive advantage.
  6. Is the company available at a 25% less than its intrinsic value? Warren Buffett carefully studies a company's earnings, revenues, and assets to get a bird's eye view of its intrinsic value.

Warren Buffett's money investment principles have touched many investors because they are simple and down-to-earth like how he maintains himself. Even with a simple lifestyle, he is considered as the second richest man in the world as of 2004.


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