Most people know that in today’s environment they need to invest properly but don’t know how to do it correctly. Which stocks to buy? What to sell? How much to invest in each stock? Listening to CNBC or Jim Cramer seems to do nothing but confuse the issue.

Discover Stocks to Buy using Warren Buffett's Strategies

When it comes to investing money in the stock market, you have a choice. You can go your own way, listen to people who are trying to sell you something, or follow the lead of someone who has already done it successfully.

Most people logically know that following in the footsteps of someone who has already done it is the best way to go. However, even with this knowledge, most people choose to go their own way and invest their money based on emotions and gut feeling or listen to the random musings of Jim Cramer. It’s no wonder there are so many investing failures and panics when the markets go wild.

However there are a small handful of people who follow the techniques pioneered by Benjamin Graham and implemented with great success by Warren Buffett and others. These techniques are paramount when investing money in the stock market.

They tell you which stocks to buy, when to buy and when you should sell.

Of course Graham and Buffett’s techniques form the basis of what is generally known as Value Investing. Unfortunately there are so many definitions for value investing that the term itself adds to the confusion.

Fortunately, Graham and Buffett have documented in precise detail what they mean when they refer to value investing. And when investing money in the stock market, you’d be wise to follow their version of value investing.

Keep in mind that Ben Graham’s value investing techniques are not exactly the same as Warren Buffett’s. While both have the same goal, which is to purchase shares at substantially below a company’s intrinsic value, the implementation details differ significantly and whereas Graham chose to sell when intrinsic value was reached, Buffett in many cases chooses not to. However Buffett’s implementation is based broadly on Benjamin Graham’s as well as a number of other people’s and it is generally acknowledged as the superior value investing strategy.

If you’re investing money in the markets and wondering which stocks to buy, I would highly recommend using Buffett’s Value Investing strategy as a basis and supplementing it with a few other complementary techniques.

The reason is because Buffett’s strategy not only focuses on returns, but on risk as well. In fact it has risk built in as a primary element. Most other investment strategies look first at returns and then treat risk as a secondary attribute, if at all, or are based on popular theoretical research that severely underestimates risk.

Investing money is simple. However it is not easy. Keeping emotions out and eliminating noise is one of the most difficult things for any investor to do. That’s the reason you need a solid, proven system that will take control of your investments and guide you through the correct investment steps even when your emotions are screaming at you to follow the crowd and give into fear or greed.

Knowing Which Stocks to Buy Involves Analyzing Risk…

Buffett’s Value Investing strategy incorporates risk at its heart. It doesn’t treat risk as a simple number based on a Gaussian curve or other statistical methods that underestimate the real risks.

Rather it treats risk as a concept that Benjamin Graham called, “permanent capital loss.”

There are three main concepts that serve to define risk: Company risk, valuation risk and earnings risk.

Company risk can be minimized by evaluating a company’s financial statements (usually its balance sheet, income statement and statement of cash flows) to determine the relative fundamental strength of the company. In addition, these statements can also tell you about, what Buffett refers to as, a company’s economic moat. Companies with strong moats are generally less risky than companies with weaker moats.

Valuation risk is based on Graham’s concept of the margin of safety. As Buffett puts it, the price you pay determines your return. The lower your purchase price, the higher your return. The higher your purchase price the lower your return. And as Graham famously stated, the margin of safety is nothing if not a form of risk management against errors and bad luck.

The third risk source, earnings risk, is, as Graham says, “the danger of a loss of quality and earnings power through economic changes or deterioration in management.”

James Montier, in his excellent book, “Value Investing: Tools and Techniques for Intelligent Investment,” writes, “the challenge facing investors… is to assess whether any changes in earning power are temporary or permanent. The former represent opportunities, the latter value traps.

Keep an eye on the ratio of current EPS to average 10-year EPS. Stocks which look ‘cheap’ based on current earnings, but not on average earnings, are the ones that investors should be especially aware of, as they run a greater risk of being the sort of stock where the apparent cheapness is removed by earnings falling rather than prices rising.”

Once these three main sources of risk have been accounted for and minimized, then the Gaussian risk management tools can be applied in order to further reduce risk.

Unfortunately, given the prevalence of theories such as MPT and CAPM by such economic luminaries as Harry Markowitz and Bill Sharpe, many investors, professionals as well as individuals, rely solely on the Gaussian risk tools and end up taking large risks without ever knowing it.

Diversification and Asset Allocation can be implemented by statistical, Gaussian, tools in order to further minimize risk, while rebalancing at the appropriate times, according to proven rebalancing techniques, ensure investors always buy low and sell high when investing money in the stock market.

If you are interested in learning how to methodically determine which stocks to buy and sell, how to diversify and rebalance correctly and a host of other investment-related concepts you need to know in order to be successful in the stock market, get my book, “The Pragmatic Investor.” It’s entertaining, easy-to-read and will most likely improve your investing skills.

 

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