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Most investors would be happy with anything like the stock market success of billionaire Warren Buffett. He has achieved legendary status because of what seems like his Midas touch in the markets.
In fact, as he himself says, a lot of Buffett’s success has been built on consistently applying some pretty simple but effective principles.
Small, private investors with just a modest amount of spare cash can apply some of those Buffett principles themselves. Here are three.
Know what you’re doing
It sounds blindingly obvious, but if you put money into a business you do not understand, you are not investing. You are merely speculating.
Yet that is exactly what a lot of people do, putting their hard-earned cash into shares without understanding how the business in question even makes its money (if it does).
Buffett sticks to his circle of competence. He has spent huge quantities of time learning about industries and specific businesses so he is more likely to know what he is getting into when he buys a given share.
Reinvest the earnings
Buffett’s company Berkshire Hathaway is rolling in cash – to the tune of hundreds of billions of dollars. Yet, rather than pay a dividend, he is happy to let it up pile up awaiting some future use.
That is an example of what is known as compounding. Rather than see dividends as passive income to fund life’s little luxuries, Buffett aims to use them to speed up his wealth building.
Even on a small scale, a private investor can do the same with any dividends they earn.
Never ignore valuation
There are multiple reasons Buffett may decide not to buy a particular share. For example, he may not comfortably understand its business or may feel uneasy about its accounting practices.
But another reason is because the share price is too high. Many people think a great business makes a great investment. Buffett is a seasoned enough market participant to know that the two things are not necessarily the same. Even a great business can make a poor investment if they are overpriced.
I apply this approach. For example, one share I have been eyeing for years is food producer Cranswick (LSE: CWK).
It is not a household name but makes a lot of food products sold in supermarkets and grocery stores. Cranswick has honed a highly successful business in this rather unexciting-sounding field. It has grown its dividend per share annually for more than three decades.
Cranswick has developed an extensive network of food production sites and developed deep relationships with customers. It has honed a consistently profitable business model.
One risk I see is reputational damage. Cranswick has attracted negative headlines this year relating to the conditions at one of its pig farms. That could hurt customers’ enthusiasm for its products, and so damage its revenues.
At the right price, I would be happy to buy Cranswick shares. However, at 22 times earnings, the share price is higher than I am willing to pay. So for now, I will do what Buffett sometimes does for years with a share… watch and wait.
