Warren Buffett has amassed a net worth in excess of $140bn. However, his number-one lesson is as useful to you and me as it is to him. So what’s this great piece of advice? Well, it’s simple: “Don’t lose money”.
It’s hard to recover from a loss
I’m one of those weird people who works with Bloomberg TV on in the background all day. It’s certainly useful, but I always remember a clip from an old advertorial — which was shown probably every 30 minutes — in which, I believe, Bill Ackman says “If you lose 50%, you’ve got to go 100% to get back to where you started”.
It’s very obvious, but it’s something I think many novice investors overlook. Recovering from a loss on an investment, notably one as large as 50%, is very challenging and, for some investors, they may find it impossible.
Putting this lesson into practice
Putting these lessons into practice is, in part, straightforward. Diversification’s necessary to avoid losses having an existential impact on an investor’s portfolio. This doesn’t mean we can’t invest in high-reward stocks, but it means we hedge our bets by spreading risk.
The next step is investing in stocks with a margin of safety or a really strong value proposition — this is actually another Buffett lesson. For me, this tends to revolve around the price-to-earnings-to-growth (PEG) ratio as my focus is growth stocks. If the stock in question trades with a significant PEG discount to the wider sector, then it’s something I’ll consider.
Incremental gains
As such, the objective isn’t to invest all our money into one stock and hope for a multibagger. Instead, it’s about investing in a range of stocks with strong prospects with the objective of significantly beating the market.
So how can £1 turn into £1m? The answer’s with £500 of monthly contributions, 26 years, and an average return of 12% — that’s above average for novice investors, but many achieve much stronger growth.
One stock to consider
I keep banging on about a stock called Celestica (NYSE:CLS), but I think it’s a good example of how people can think about investing with a margin of safety. The Canadian company designs, manufactures and provides supply chain solutions for the electronics industry. And the stock’s recent surge has been driven by demand for its switches and routers — and other items — which are vital for data communications and information infrastructure, especially in artificial intelligence (AI).
Now trading for $110 a share, I first bought Celestica at $26, but I still think the stock offers good value. That’s simply because the company’s performance gets better and better while medium-term forecasts have improved. Even now, the stock trades with a PEG ratio of 0.91 — a 51% discount to the information technology sector average.
The company could definitely have stronger margins and there are reports that sales are quite concentrated among a handful of top customers. However, I still think this is a great stock and worthy of further research. I’d buy more but it already exceeds my own rules for concentration risk.
This post was originally published on Motley Fool
