I share how I pick stocks to invest in based on how legendary investors Warren Buffett and Charlie Munger pick stocks. Yes, this is a How To Pick Stocks recipe! 😀
These methods are also based on value investors that have followed in Buffett and Munger’s footsteps, Phil Town and Danielle Town. I highly recommend their Invested book and Invested podcast so you can learn the specifics of how to pick stocks.
It’s important to set goals and a promise to yourself that you will set out to achieve your financial dreams and promise yourself that you’re going to stick with the investing process.
Even though we all want to make money in the stock market, you gotta know there’s always risk in investing. There’s no such thing as a safe bet when it comes to investing. Make sure you’re fully aware of the kinds of risks that there could be with investing, but you do your best to get educated so that you can mitigate those risks.
Then you make the best possible educated guess as to what you’re investing in, because none of us really know, and if we did know then we’d be the executive management of a company and maybe that could be insider trading, which wouldn’t be good.
I describe how we can pick stocks in a tried and true way that I think will be helpful to you because I have tremendously benefited from following this process.
When we invest, our hope and expectation is that our investments will go up in value and in price over time, but I found that it’s better to not think of it as “I need to make money” but instead to think of it as in how Buffett puts it:
“Rule #1: Never Lose Money. Rule #2: Never Forget Rule #1.”
It’s critically important to try to change around how we think about our approach to investing in stocks. We all want to make as much money as possible, but that kind of pressure we might put on ourselves doesn’t necessarily help us.
So it’s more important to try to protect our principal when we’re investing so we never lose our money, hopefully.
I encourage us to follow Charlie Munger’s 4 principles of investing as closely as possible:
M1. Meaning: We are capable of understanding it
M2. Moat: Intrinsic characteristics that give it a durable competitive advantage
M3. Management: with integrity and talent
M4. Margin of Safety (MOS): Buy at a price that makes sense and gives a MOS
We want to buy companies at valuation with a significant discount to what the company is or had been selling for in the market. Then we can buy a stock on sale, ideally at 50% or more. Make sure you keep Charlie’s principles in mind as you’re going through this investing process I’m outlining.
I wrote out the 8 steps to prepare you for how to invest:
- Identify companies and industries you might be interested in
- Start building a Wish List of companies you’re interested in learning more about or buying
- Check companies’ “Fundamentals” or financial info on GuruFocus or Yahoo Finance
- Look at companies’ 10-K Annual & 10-Q Quarterly Reports and Gurus’ 13F Filings
- Choose & read a “newspaper” (online) for business news to keep tabs on your companies
- Complete Charlie Munger’s 4 Investing Principles before you might buy
- Calculate companies’ intrinsic value and margin of safety valuations to know buy prices
- If a company’s stock is on sale, buy and hold forever! Ideally.
Within Step One, if you recall from Charlie’s first principle, the companies we identify have to have meaning to us. So I’ll talk about one company that has meaning to me: Starbucks!
You can learn about companies that might be of interest to you by visiting stock screeners such as ones from Yahoo Finance. I use consumer cyclicals and restaurants as an example to show the industry that Starbucks is competing in, and potential big market cap food competitors include McDonald’s, Chipotle, and Yum Brands.
You can organize this data in a spreadsheet and compare restaurant companies, for example analyzing them by market cap size or Price To Earnings (PE) ratios. Chipotle at around a 90 PE ratio (historical average of stocks is around 15-16 PE) seems really pricey so I’d rather just make my burritos at home.
Another thing you can do to figure out what companies and industries you might be interested in is to do what the Towns came up with, which is The Three Circles Exercise. You consider how you’re spending your money, how you’re voting your money, and what you’re passionate about and I share examples from my life and experiences.
Step Two is to start building a Wish List of companies, and I share one of my examples of companies I either own or am interested in buying. It’s important to have this Wish List ready on hand so when these companies go on sale you can buy them as long as you’ve done your homework.
Step Three: start familiarizing yourself with a company’s fundamentals or its financial info that you can find on places like GuruFocus or also Yahoo Finance.
By looking at some of these factors, we can look at which factors might be useful as we’re building our investment case for any particular company.
Step Four: You want to look at and read companies’ annual reports that are called 10-K or their quarterly reports called 10-Q as well as check out guru investors’ 13F filings with the SEC. You can find the company reports by visiting the company’s Investor Relations website, which I like because they have most of the annual reports for several years so you have access to the raw data in order to do your own calculations.
This can also help you keep tabs on how companies are performing quarter to quarter or year to year, but my favorite is to not have to keep up with some of these quarterly activities and just invest for the long term, like at least 10 years or forever.
It helps me to know what superinvestors or gurus I admire are investing in because it can help to reassure me if people are also investing in the same stock. Bill Ackman used to invest in Starbucks but sadly no guru I follow currently is invested in SBUX.
This can give you a clue as to if you’re on the right track with companies you might like to invest in.
Step Five: Choose and read a “business newspaper” (online mostly) such as the Wall Street Journal. Check articles online about companies and industries you’re interested in.
Step Six: You want to finish completely answering Charlie’s 4 Principles for yourself. This includes evaluating the moat and management of the company. The company’s moat is its competitive advantage that helps it last for a long time.
I believe Starbucks has a pretty good brand moat, a lot of people recognize it worldwide from its deep green Siren logo even without having to associate the name.
I also think it has a bit of a switching moat and a little bit of network effects moat. People who are addicted to Starbucks coffee don’t usually switch. They also have this gold star rewards program where people rack up gold stars to be redeemed toward food and drinks.
It doesn’t seem like Starbucks has much of a toll bridge, secrets, or price moats, however.
When it comes to management, we want to make sure they have integrity. For years there was legendary CEO and Chairman Howard Schultz and since 2017 Kevin Johnson has been at the helm. It’s important to try to figure out if he has integrity and is running the company in a good way, and there are objective measures to gauge this. One of them is Return On Invested Capital to see if the CEO is doing a good job, or if he’s racking up a lot of debt for the company. We can take a look at his insider trading activity to see how committed and invested the CEO is in the future success of the company.
Step Seven: This is Charlie’s 4th Principle of Margin of Safety. You want to buy a wonderful company at a price that makes sense and gives a MOS.
This means you have to calculate what you think will be the intrinsic value of the company in the future. And then you want to buy it on sale or at a MOS price because you’re trying to give yourself enough margin for error in case you’re wrong about the future. The company may or may not live up to the intrinsic value that you’ve calculated.
But you’re buying it at such a discount to what you believe will be its full value in the future that you can’t help but likely do OK in the end.
When you’re focused on trying to calculate these MOS numbers, you’re looking back at the company’s financial statements which include its cash flow statement, income statement, and balance sheet. You can find this info on its 10-K or in online tools.
I’ve also gathered financial indicators from each of the 10-Ks to identify growth patterns of where the company has been and where it might be heading.
Return on Invested Capital (ROIC) is very important as I mentioned earlier so I can ascertain how likely this company is to grow at certain growth rates in the future. This can help inform how I value the business.
Step Eight: If a company’s stock is on sale, we can buy and hold forever, ideally! So we rest assured we’ve done everything we can to know what we’ve invested in.
I summarize Charlie’s 4 Ms as they apply to Starbucks to me. Yes, coffee!!! That’s what it’s all about. I include a few quantitative measures of how management is performing and my margin of safety valuations/prices based on a somewhat lower windage growth rate but higher windage PE ratio guesstimates.
If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.
I look forward to making more investor friends! Add me on Instagram: michellemarki! 🙂