First, make yourself invincible, and then wait for the enemy to be vulnerable : First, ensure you won’t incur losses, and then patiently wait for the right opportunity to enter a trade to seek profit
"First, make yourself invincible, and then wait for the enemy to be vulnerable."
(The Art of War : Tactical Dispositions)
Applied to stock trading, this means first making sure you won’t incur losses, and then patiently waiting for the right opportunity to enter the market to seek profits.
Buffett advises investors: "One fundamental rule of investing is to protect your capital. Be calm and patient, wait for the right opportunity, otherwise, it's better not to act at all." Buffett believes that to profit from investments, the first step is to avoid losses. "To win, the first thing you have to do is not lose." – Warren Buffett
This statement emphasises the importance of avoiding losses. In investing, losses are much harder to recover than gains. Consider this: if you lose 50% of your capital, you would need to double your remaining funds just to break even. If your average annual return is 12%, it would take six years to recover. Therefore, preserving your capital before thinking about making profits is crucial.
Hence, the primary task is to avoid losses to ensure the safety of your investment portfolio. Buffett has set two rules for his investments:
Rule No.1: Never lose money.
Rule No.2: Never forget Rule No.1.
These two rules highlight the importance of protecting your capital in investment decisions. "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1." – Warren Buffett
Make yourself invincible
(Avoid Losses)
Buffett places extreme importance on avoiding losses, making capital preservation the foundation of all his investment strategies. The "value investing theory" he advocates is not about maximising profits but minimising risk.
So how does Buffett achieve "making yourself invincible"? He believes that by purchasing and holding quality companies for the long term at prices below their intrinsic value, rather than frequently trading in the market, one can effectively reduce investment risk and thereby minimise the likelihood of losses.
Additionally, Buffett only chooses to invest in quality companies. No matter how cheap a failing company may be, he will not invest in it. One of Buffett's most important pieces of advice to investors is: "It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
The quality companies Buffett refers to should meet the following criteria:
1. Competitive Advantage (Economic Moat): This is a factor that Buffett highly values. He prefers to invest in companies that have a competitive advantage in their industry, which can include brand recognition, patented technology, cost advantages, economies of scale, and more. These advantages help companies maintain a leading position in the market and fend off competitors. Buffett likens a company’s competitive advantage to a wide moat surrounding a fortress, filled with sharks and crocodiles, making it impenetrable to any invaders.
2. Stable and Predictable Profitability: Buffett favours companies with stable profitability. These companies can generate consistent cash flow and earnings through various economic cycles. This stability makes it easier for investors to estimate the company’s future cash flows and value.
3. Excellent Management Team: Buffett pays close attention to the capabilities of a company’s management team and prefers companies led by talented and trustworthy managers. He believes that the management team plays a crucial role in the long-term success of a company.
When assessing the management team’s capabilities, Buffett usually studies whether they can effectively reinvest or redistribute earnings to create greater profits for investors. Buffett believes that if a company can fully utilise its earnings for reinvestment to expand its business, its growth potential will be unlimited, thereby bringing greater returns to shareholders.
4. Healthy Financial Condition: Buffett tends to invest in companies with strong financial health, which includes low debt levels, sufficient cash reserves, and high profitability. These factors help companies deal with unforeseen challenges and seize opportunities to grow their business.
5. Sustained Competitive Advantage: In addition to having a competitive advantage, Buffett also wants these advantages to be sustainable, not just short-lived. This means that a company should have a degree of durability, allowing it to maintain its competitive edge in the future. Buffett has said, "The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage." For Buffett, if a company has a lasting competitive advantage, it can remain successful in a highly competitive market, and high investment returns for investors will only be a matter of time.
6. Low Asset Replacement Costs: Asset replacement refers to a company upgrading and renewing its fixed assets to maintain its operations and competitiveness. Companies with high asset replacement costs usually have a significant amount of fixed assets and need to spend large sums of money on maintenance, upgrades, and renewals. Buffett likes to find companies that can grow without needing substantial financial support, such as Coca-Cola and See’s Candies. These companies can establish a monopoly in the consumer market through their intangible assets, without relying heavily on physical assets like plants and equipment. Additionally, these companies do not require significant spending on technology investment and equipment renewal. As a result, they can retain a large amount of cash earnings, which are ultimately distributed to shareholders, leading to increasing shareholder returns year after year.
While Buffett focuses on high-quality companies and management teams, he also emphasises that he only invests when the price is reasonable. He doesn’t blindly chase stocks but waits for the opportunity to enter the market at a reasonable price and then holds these quality stocks for the long term. This comprehensive approach helps to reduce investment risks, minimises the potential for losses, and increases the chances of investment success. "We like a business with enduring competitive advantages that is run by able and owner-oriented people. When these attributes exist, and when we can make purchases at sensible prices, it is hard to go wrong." – Warren Buffett
Wait for the enemy to be vulnerable
(Waiting for the right moment)
Buffett is famous for his value investing philosophy, where he is adept at waiting for the right moment to purchase stocks of high-quality companies at prices below their intrinsic value. Usually, the stock prices of high-quality companies tend to be high and relatively stable, making it difficult for investors to buy at a discount. However, the market occasionally presents opportunities to buy such stocks at low prices due to factors like economic downturns, industry recessions, short-term events, corporate restructuring, or wars. During these unstable times, most people tend to avoid the stock market, but Buffett seizes these opportunities to buy quality stocks at discounted prices. Throughout his investment career, Buffett has been looking for such discounted trading opportunities, believing that the larger the discount, the greater the potential profit, and the smaller the risk of loss.
To ensure he is always ready to seize these opportunities, Buffett usually maintains a large cash reserve and patiently waits for the right moment. When the right opportunity arises, he decisively and greedily buys up high-quality stocks at low prices. This is Buffett's "Wait for the enemy to be vulnerable" investment strategy. "Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble." – Warren Buffett
Sun Tzu said: "Thus the skillful warrior places himself in a position that makes defeat impossible and does not miss the moment for defeating the enemy. Thus it is that in war the victorious strategist only seeks battle after the victory has been won, whereas he who is destined to defeat first fights and afterwards looks for victory." This means that one must first ensure capital preservation and not act rashly. Once action is taken, it must be with the utmost confidence in victory. By buying high-quality company stocks at a reasonable price or below their intrinsic value, the risk at the time of purchase is minimized. With patience, the quality company will eventually deliver substantial returns on your investment.
