Warren Buffett: 3 vital rules the world’s best investor follows

Buffett at the BRK AGM

To many, Warren Buffett is considered to be one of the greatest investors alive today, perhaps even of all time. After all, he’s managed to turn a $105,000 initial investment in 1956 into a $767bn company called Berkshire Hathaway today. His own net worth has increased drastically and sits at over $117bn. And all of this was achieved by making intelligent investments in the stock market.

Replicating his returns is no easy feat. After all, he’s delivered close to a 20% annualised gain to shareholders since the 1960s. But as every investor knows, earning just a few extra percentage points is enough to drastically accelerate the compounding process in the long run. So with that in mind, let’s explore three of his most important tactics.

#1: Share price doesn’t matter

Considering stock prices are plastered all over financial news publications, ignoring their movements may seem nonsensical. But as a long-term investor, Buffett isn’t buying stocks. He’s purchasing businesses. As such, his focus is on evaluating the performance of the underlying business rather than using technical analysis to find and predict patterns in a stock price chart.

In the long run, share prices will move to reflect the intrinsic value of the company. So if the business does well, the stock will eventually follow. Determining whether a company is high-quality or not requires quite a bit of nuance. And this process lies at the heart of picking stocks.

However, there are some consistent themes Buffett is on the lookout for. The most notable is the presence of competitive advantages. A company that can maintain a continuous upper hand against its rivals is far more likely to capture market share, achieve growth, and deliver value to shareholders.

#2: Know your limits

Intelligence doesn’t always equal wisdom. And even the smartest investors in the world have gaps in their knowledge that can lead them to make some poorly informed decisions. That’s a crucial mistake which Buffett has largely avoided by simply staying within his ‘Circle of Competence’.

Instead of chasing every exciting opportunity, he sticks to companies that operate within industries which he understands well. Of course, he’s still made plenty of mistakes over the years. And by ignoring complex operations, he’s also missed out on some terrific investments. Yet it’s also arguably why he’s avoided multiple disasters over the course of his career.

#3: Patience is a virtue

Even if an investor identifies one of the best companies in the world to invest in, getting rich likely won’t happen overnight. Businesses take years to execute strategies and build value for shareholders. As such, following Buffett’s investment strategy largely consists of just waiting.

This inaction can feel alien, especially when looking at the portrayals of investors in movies and TV series. And this is especially true during a correction or crash where the gut instinct is to start selling before prices collapse. However, doing nothing is often the smartest decision.

In the short term, it can be painful to watch a position suffer. But what’s worse is watching a previously sold stock skyrocket to new heights as the firm delivers on its long-term potential.

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Zaven Boyrazian 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.