Legendary investor Warren Buffett is famed for his success in the stock markets, but also sharing his insights and investing wisdom widely.
Before I buy a share, there are three questions inspired by Warren Buffett I tend to ask myself. If I answer even one of them negatively, that will typically be the end of my thought of buying that share at that moment.
Do I understand the business?
Warren Buffett talks about aiming to stay inside his circle of competence when investing.
In other words, he aims to avoid things he does not understand.
That seems simple enough. When a hot new stock is soaring, though, it can be easy to get carried away with its momentum and not pay enough attention to the underlying business.
But if I do not really know what a company does and what its sector looks like, I cannot assess its competitive advantages and how its prospects look.
Does the balance sheet put me off?
Most people’s idea of a good way to spend a few hours is not poring through hundreds of pages of a company’s accounts.
Then again, most people do not have anything like the stock market success of Warren Buffett.
Buffett pays close attention to a company’s published accounts before investing – and for good reason.
A listed company is obliged to include certain information in its accounts, such as its borrowings and cash flows.
Understanding such figures can help someone get a detailed picture of a business.
During the 2008 financial crisis, when Lehman Brothers hoped Warren Buffett might step in to help save it, the Sage of Omaha did not rely on endless meetings with Lehman’s management to make the call.
He sat down and read the company’s most recent publicly available accounts for a few hours. He saw red flags that made him decide then and there he would not be investing.
Is the price attractive?
Early in his career, Warren Buffett was what is known as a value investor.
As the name implies, he was focused on buying things cheaply.
Later, in a shift he credited to his partner Charlie Munger when they were negotiating to buy See’s Candies, Buffett changed approach. Rather than focusing exclusively on cheapness, he now sought to buy into attractive companies at what he called fair prices.
I think this makes sense. Take Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) as an example.
The share price is up 134% over just one year and 235% over five. I think the company continues to have great prospects. But at its current price, I am not ready to buy. Why?
Alphabet currently sells for 30 times earnings. That may not seem outrageously high, especially in the context of tech shares today.
But I see it as being on the expensive side.
Yes, Google is a strong brand with a huge user base. YouTube has ongoing growth potential and AI could help propel Alphabet’s earnings higher by reducing staff costs.
But it could do the opposite. Like peers, Alphabet is spending heavily on infrastructure for AI. Its AI rivals also pose a threat to its search business.
So although I see it as a great business, the current Alphabet stock price strikes me as high. For now, I will not be investing.
Christopher Ruane has no positions in Alphabet. The Twelfth Magpie has recommended Alphabet. 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 and Hidden Winners. Here at The Twelfth Magpie we believe that considering a diverse range of insights makes us better investors.
