Legendary investor Warren Buffett has a number of rules he lives by when it comes to picking stocks and building out a portfolio. Though the first of these is "never lose money," the core of his investing guidelines is simply to understand a business before investing in it.
"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, 10 and 20 years from now," Buffett wrote in a 1996 shareholder letter. "If you aren't willing to hold a stock for 10 years, don't even think about owning it for 10 minutes."
His strategy — which he has been careful to never stray from — essentially amounts to value investing, a practice that usually refers to buying underappreciated stocks at a low price and holding them long-term.
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In Berkshire Hathaway's 2022 annual report, Buffett highlighted the company's $1.3 billion purchase of 400 million shares of Coca-Cola in 1994. He said Berkshire received a $75 million cash dividend from Coke in 1994, a cash dividend that grew to $704 million as of 2022.
Likewise, Berkshire's 1995 purchase of American Express stock resulted in an annual dividend in 2022 of $302 million, up from an initial $41 million dividend.
"The weeds wither away in significance as the flowers bloom," Buffett wrote. "Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well."
Buffett's devotion to that rule of always understanding a business before investing in it led Berkshire to famously avoid investing in Google and Amazon in the early 2000s, because he didn't understand the internet business well enough to invest in it.
The Oracle of Omaha said in 2014 that investors ought to look at stocks as businesses: "If you’re going to try to buy and sell them based on news or something your neighbor tells you, you’re not going to do well," he said.
"Find a good bunch of businesses and hold them."
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This value-focused, business-first approach is one that Tesla (TSLA) -) CEO Elon Musk wishes more investors would follow.
Responding to a post where Citadel CEO Ken Griffin explained how active managers at investment firms essentially set the price of a stock that is later affirmed by passive investors, Musk said that there are too many passive investors in the market.
"People should invest in companies directly where they think the product or service is great," he wrote in a post on X.
Agreeing with Griffin's point that active managers are the ones who set valuations, Musk said that, in his opinion, "passive is too large a portion of the market."
Passive investing traditionally refers to an approach where investors buy an index fund that tracks a major index, such as the S&P 500. The passive goal is built upon a longer-term mentality.
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