5. Warren Buffett Stock Basics

Warren Buffett's 4 rules for buying stocks

1. A stock must be stable and understandable
2. A stock must have long term prospects
3. A stock must be managed by vigilant leaders
4. A stock must be undervalued

A Warren Buffett valuation technique

• Market Price: $10
• Earnings: $2 (Potential returns)
• Book Value: $.70 (Margin of safety)

P/E = $10/$2 = 5
Returns = 20%

P/BV = $10/$0.70 = 14.3
Every 14.3 dollars paid for this company has $1 in Book Value

Trade-off: Earnings vs. Book Value

Warren Buffett looks for P/E 15 or lower and P/BV 1.5 or lower. To make it simple, combined these two values, we want to look for a company that has P/E * P/BV < 15 * 1.5 = 22.5

Warren Buffett's opinion on the market

The market is nothing more than a place you go to buy or sell stocks. "I buy on the assumption that they could close the market tomorrow and not reopen it for five years". Some days you'll get offered great buys, and other days you'll get offered horrible deals. Your job is to know when it's a bad deal.

Patience and individuality

• Patience: Anytime you find something that looks like massive returns usually means massive risk. Pigs get fat and hogs get slaughtered. Patience is truly a virtue. Take your time. Don't try to get rich overnight. Never break your rules!
• Individuality: Think for yourself. That's what all the great investors do! I've often found that if I was doing what everyone else was doing... I was probably doing it wrong.