Warren Buffett remains one of the most successful long-term investors in the world. And the driver for his stellar track record can be boiled down to one single simple rule – his ‘golden rule’. And it’s a tactic that all investors can use to help build wealth. This is especially true for 25 year-olds who’ve just started their investing journeys from scratch.
So what is this golden rule? Well, in his own words: “Never lose money”. Sounds pretty obvious. But digging deeper reveals a wealth of wisdom that propelled Buffett’s investment firm – Berkshire Hathaway – into trillion-dollar territory.
Don’t lose money
Losing money in the stock market’s inevitable. Even Buffett made plenty of bad investments over the years, which crumbled into oblivion. That’s because even the most well-researched company can still end up derailed by an unforeseen external force. Just take a look at what happened to the travel industry in 2020.
But by constantly investigating businesses, their prospects, and risk factors, it’s possible to make a far more informed investment decision. With this knowledge at hand, it becomes far easier to avoid falling into traps and identify the best opportunities for long-term growth.
One of Buffett’s favourite tactics in this pursuit is deploying a margin of safety. After finding a possibly terrific enterprise, he’s looking for an equally terrific price. The cheaper the price, the wider the margin of safety, reducing the risk of losing money while maximising returns.
Finding value
One of the easiest and most popular methods of finding undervalued enterprises is the price-to-earnings (P/E) ratio. By comparing the P/E multiple of a company to its industry average, investors can potentially discover attractive buying opportunities.
Let’s take a look at ITV (LSE:ITV) as an example. Right now, shares of the advertising-based streaming platform are trading for a price-to-earnings multiple of 7.4. Compared to the industry average of 9.8, the stock’s seemingly priced at a 24.5% discount.
That certainly sounds like a strong Buffett-like margin of safety. So does that make ITV a terrific buy right now? Well, not necessarily.
Firstly, it’s important to highlight the assumption that the industry average represents a fair price for ITV. Yet, even if that’s the case, there’s still an extra step for investors to take. And that’s finding out why shares are trading at a discount in the first place.
Digging deeper
ITV’s recent financial performance hasn’t been terrific. With advertising playing a critical part of its revenue stream, the reduction of customers’ marketing budgets has adversely impacted growth. Meanwhile, high capital expenditures related to content creation, paired with project delays from US industrial action, haven’t exactly helped matters.
On the one hand, these are simply short-term challenges that may naturally resolve themselves now that economic conditions are improving across the world. On the other hand, management’s put a lot of capital into producing new shows that may fail to live up to expectations. And that could be a costly mistake.
Young investors will have to decide whether a near-25% discount is sufficient to take on these risks in the pursuit of higher returns.
This post was originally published on Motley Fool
