5 Principles for Value Investing

WARREN Buffett is the world’s most successful value investor.

Very few people have ever managed to achieve his level of investment success.  The interesting thing about that fact is that there are only a few simple principles that you need to know if you want to be a successful value investor.

  1. Stick to your Circle of Competence – only invest in companies that you understand.
  2. Value Stocks as the Part Ownership of a Business
  3. Focus on Intrinsic Value – determine the underlying value of a business rather than looking at how much the market might be will to pay. Factors to bear in mind when figuring out the value of the business:
    • Business Drivers – what is the company’s business model? How do they make money?
    • Low Leverage – how much debt does the company have? You want to see as little cash going out of the business as possible.
    • Cash Flow – how much cash flow does the company generate? You want to see more and more cash coming into a business over the years.
    • Sustainable Competitive Advantage – what kind of natural advantages does the business have? To sustain and grow earnings the company needs a large moat with alligators in it. Large moats might come from (1) strong brand, (2) patented technology, or (3) incumbent low cost position in a market with economies of scale.
    • Prospects for Growth – what kind of profitable opportunities are available to the business?
    • Quality Management – the company needs honest and able management because an investor should not need to keep checking whether management is doing its job.
  4. Invest with a Margin of Safety – there is always investment uncertainty, so the price should be low enough to ensure that you have a “Margin of Safety”.
  5. Think Independently – it is difficult to outperform the market if you follow the market. Think independently and “be greedy when others are fearful”.

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