Wednesday, August 31, 2011

How Warren Buffett Became a Billionaire

Long term investors follow a wide range to investment strategies to get maximum returns. But for beginners we will discuss here two easy to follow tips that are easy to apply and perhaps the most rewarding. Investor must keep it in mind that when we are talking about long term investment we are talking about time span of 10-15 years.
Invest in Large Cap Companies
Investment in large cap companies has two big advantages:
  1. These companies work really hard to enhance the shareholders value with passage of time. So you can be virtually sure of seeing the market price of these stocks rise year after year. But investors should just take one care of not investing at the peaks. Do a small technical analysis and try to put your money in valleys and not on peaks.
  2. These companies pay reasonable dividends each quarter/year to its shareholders. These dividends are in addition to gradual growth of market price of stocks as explained in (1) above. The dividends earned form these stocks can be reinvested by purchasing more valued stocks.
This style of investing is followed by Warren Buffett and has made it a point that “it is better to buy stocks of great companies at reasonable price than to buy reasonable companies stock at a great price”. Warren Buffett in general likes to own stocks of companies that is largest in its sector and has proven track records. Or else he buy stocks of only those companies which has been thoroughly researched by himself. He never invests outside his circle of competence.

Let’s take an example how the stock prices of these large cap companies grows in average. Let’s assume that the stock price of a company is $100 and its P/E ratio is 10 and EPS is $10. If EPS is expected to grow at the rate of 10% per annum means after one year EPS will grow from $10 to $10.1. If the P/E ratio is assumed to be 10, then Market Price of stock will be P/E x EPS = 10 x $10.1 = $101. Generally the P/E ration of large cap companies stays very stable, so it will not be absurd to assume the P/E ratio as practically constant.

Invest only when there is a fall in stock market
This strategy is my favorite. It is one of the coolest and most fool proof strategy I have heard and followed in my investment career. But it requires a great deal of patience and perseverance on account of the investor. It is like a big hawk waiting for the right time to attack its prey. Even an unqualified investor can resort to this system of long term stock investment. They need to do just two things to make this investment strategy work to their advantage:
  1. Save regularly and put this money aside and treat it as spent. It is easier said than done. Money safely parked in savings account is occasionally spent on trivial things of life. This is the hardest part of this form of long term investment. Goal is to have enough money in hand when the stock market has fallen to dramatic lows.
  2. Wait for the market to fall. Stock market is like waves of the ocean the higher they rise the faster they meet the ground. Investors must wait and watch the tides to get humble. Once you see the prices of stock almost 2/3rd of they book value prices (this happens with large cap companies only during financial crisis), put all your money saved in one (1) above to buy stocks.
This is the reason why all long term and value investors will have a wide smile on their faces when they see the stock market indices falling dramatically. When all other investors are cursing their fate they smile form ears to ears showing expressions of extreme satisfaction.

Follow any of the above long term investment strategy and see your wealth soaring sky high. Be patient, keep your eyes open and the mind alert.
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