Warren Buffett may well be the most successful investor of all time. He became a billionaire in the 1980s and his stewardship of Berkshire Hathaway has seen the company’s A-shares reach a value of over $400,000. What can we learn from him? Well, lots actually. Over the years, through interviews, books, and letters, Buffett has given a detailed account of how he makes the sorts of investments that reap double or even triple digit returns. Here are some of his tips I’m using to help build passive income for my own portfolio.
Fundamentals, not share price
Warren Buffett always stresses the importance of the business fundamentals. For the most part, watching a stock go up and down is stressful, exhausting, and unhelpful. Many new investors make the mistake of buying when the price goes up and selling in a panic when it goes down. But so many factors effect share prices in the short term. Not only is it impossible to predict these swings, but often they tell us nothing about the health of a company.
If, however, an investor familiarises themselves with how much debt a company has, how much cash it has on hand, and if it turns a steady profit, they will be in a much better position to know if the company is healthy or not.
How does this apply to passive income? If a company pays a dividend (a portion of profits allocated to shareholders) it’s important to know if the amount it pays is affordable. Will paying dividends today hurt the company in the long run? You don’t need to be a genius to read a company’s financial statement, and it helps us choose which companies are worth investing in.
Invest in what you understand
The next most important tip is understanding what you are investing in. Buffett has often been criticised for missing out on the tech boom of the last 20 years. But he has always been open about the fact that he doesn’t understand how those companies make money, so he doesn’t invest in them. That’s not to say that Facebook or Google are bad companies, only that he wouldn’t be able to tell the difference between them and bad tech companies. I personally don’t invest in banking for this same reason, but I do invest in renewable energy.
It is always a good idea to try and learn more about different business sectors as we grow more confident in our investing, but Buffett suggests we focus on what we already know well. Peter Lynch, another famous investor, echoed this sentiment in an interview with CNN. “I know restaurant managers who invest in IBM, but I always ask why they don’t invest in restaurants. They know what sorts of challenges they face and know if a restaurant is profitable. They know how that business works”.
Patience
Lastly, Buffett is adamant that an investor should be patient. There might be a great company out there, but if the share price is too high, it’s better to wait for it to come down. There could be a market crash and your investments may go down in value, but if you wait the price could come back up.
It might not feel like it, but stock market will always present new opportunities. We just need to wait for them.
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James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
