Legendary investor Warren Buffett has built his reputation by developing a tried-and-true model for picking quality stocks and making savvy investments. This has led to Buffett's having beaten the market by an almost absurd margin over time.
Followers debate the merit of following his method to a T or forging your own path based on his sound and freely given advice. Does it make sense to buy what Buffett buys, or strike out on your own? Let's examine the options.
Investing with Buffett
The simplest way to invest like Buffett is to invest in Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) stock. Buffett himself loves the idea of individual investors benefiting from stock market movements though investing in an S&P 500 index fund, but investing in Berkshire Hathaway lets you benefit from Buffett's investing wisdom without doing the work yourself. Of course, you can buy shares of Berkshire Hathaway in addition to others.
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Picking the same stocks as Buffett isn't necessarily the best way to go, unless you buy shares of Berkshire Hathaway stock. That's because Berkshire Hathaway is a lot more than its equity positions. Did you know that as a holding company, it owns more than 60 companies, including the railroad BNSF and Benjamin Moore paints? There's a lot that goes into Buffett's decisions, as a steward of other people's money, that doesn't match up with every individual investor's investment strategy. For example, Buffett loves to buy stocks that pay dividends. That's in part because a company that pays dividends is committed to its shareholders and usually has tons of cash. But it's also because Berkshire owns millions of shares of the companies it invests in and gets billions of dollars annually in dividends alone from these investments. It can do many things with that cash that are beneficial for the company and its own shareholders.
The average investor can get some amount of diversification from investing in Berkshire Hathaway stock, but you may want to take it a step further and use Buffett's sage advice to create your own investing plan.
Investing like Buffett
Buffett's pretty clear about what looks for when buying a company or its stock. He looks for what he calls a great business, and he has repeatedly said that a great business is defined as having excellent, honest management, and most importantly, a long-term competitive advantage. He also seeks varied earnings streams and a focus on cash generation.
It's not only that. Berkshire took three new positions in the second quarter, all in homebuilder stocks. That's not only because each one of these happens to fit his criteria. Clearly, Buffett sees a trend, and he's seizing the opportunity to ride it.
Individual investors can follow the Buffett playbook to benefit from this trend or others by finding stocks with these attributes. One advantage to doing it on your own is that you have more flexibility to take quick action when you own stocks personally. Since there are more factors for Berkshire Hathaway to consider when it takes or sells a positions, it may not change its position so quickly even when market conditions change.
Although Buffett has said that his favorite holding period is forever, investors should not take that as dogma. Buffett sells stocks all the time and counsels others to do the same. "There's no rule that you have to invest money where you've earned it," he has said. "Indeed, it's often a mistake to do so."
Benefitting from market dynamics
Another feature that's important to Buffett is that a stock is not overvalued. So while you can't control market forces or their impact on stocks, you can look for opportunities to buy stocks at great prices. When stock prices become inflated, it might be your signal to sell. But when prices are low, you can find great investment opportunities. Another popular Buffett-ism is "to be fearful when others are greedy and to be greedy only when others are fearful."
Investing in an index fund or Berkshire Hathaway, plus your own set of stocks that meet your personal goals, is an excellent strategy for maximizing potential while minimizing risk.
