Investing in the stock market can be a very lucrative activity. It certainly has been for billionaire Warren Buffett.
Most of us lack both the resources and stock market experience of the ‘Sage of Omaha’. Nonetheless, I think his investing career offers some actionable lessons I can apply as I aim to build wealth.
Think like an investor not a trader
Early in his career, Buffett did what a lot of us have done. He bought shares with what seemed a low price hoping they would rise and he could sell them.
That may sound like the whole point of investing. But without understanding why a certain share is rising or falling, just buying and selling can end up closer to speculation than investment.
Buffett’s approach evolved from thinking of shares as pieces of paper with a number attached, to seeing them as a small stake in a company. If he would not happily own a whole company, he no longer buys shares in it even if he thinks they look undervalued.
Ask basic questions about business models
Something I think Buffett does not get enough credit for is the way he assesses business models. A lot of investors focus on a company’s leadership or whether its potential target market is big enough. Buffett does like companies with largest possible customer bases.
But his approach to finding businesses is quite simple. He likes a company that has what he calls a moat. In other words, he is looking for some competitive advantage that can hopefully keep rivals at bay.
As an example, consider his investment in what is ultimately a pretty simple business – Coca-Cola (NYSE: KO). Demand for soft drinks of one kind or another is high and likely to remain that way. But the market is inundated with global and local brands competing for shelf space and customers’ wallets.
By building a strong brand and having a unique formula, Coca-Cola is able to set itself apart from rivals. It has widened its advantage by building an extensive distribution network over the course of more than a century.
Managing risks as well as hunting rewards
While Coca-Cola has been incredibly successful for Buffett, he has not bought new shares for decades.
No matter how good a business is, it always faces risks. An increasing health focus could see people lose their taste for sugary soft drinks, hurting Coca-Cola’s sales. Its profitably can also be affected by sudden surges in ingredient and packaging material prices, as we have witnessed in recent years.
So like any smart investor, Buffett does not put all his eggs in one basket. This approach is known as diversification.
Like him, I am looking to build wealth by filling my portfolio with a mixture of what I see as high quality businesses with competitive advantages, when they are selling at an attractive price.
This post was originally published on Motley Fool
