Warren Buffett has three main pillars that make up his teachings and investment policy.
- The concept of Mr. Market. Mr. Market is a made up investor who was first introduced by Ben Graham in his book The Intelligent Investor which quickly became Buffett’s favorite book. Mr. Market is a hypothetical investor used to describe the stock market who is driven by emotions such as panic and euphoria as opposed to logic. His investing decisions are made based on his mood as opposed to analysis. Because of this, on some days you may be able to get great value from cheaply discounted stock in a great company, on other days he is overly optimistic and charges ridiculous premiums on his company. Smart investing is all about when Mr. Market is providing great companies at a discount.
- A second concept he uses that is key in all his investments is called a margin of safety. This means he always buys stock when he feels the value being delivered is higher than the actual price you pay for the stock. This difference between intrinsic value and price is known as the margin of safety. The larger the margin of safety the better because it minimizes your risk in the investment.
- The third concept might be the simplest. It is known as the circle of competence. This means that Buffett advises investors to only consider stocks in types of businesses that they are capable of understanding with relative ease. This helps to avoid irrational or risky investment decisions. If you are investing in technology stocks or some type of fast-paced industry you do not understand you are much more likely to experience large losses. Stick to what you know and understand.
SUMMARY: Warren Buffett has three key investment pillars: Mr. Market, investing with a margin of safety, and investing in what you know and understand.