Understanding the Stock Market


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You don’t have to be a professional investor to know the value of understanding the stock market. Many investing experts and financial advisors alike easily point to investing guru Warren Buffett, the fourth richest man in the world, to be one of the greatest investors of this past century. Being one of the most regarded investors of his lifetime, Warren Buffett has offered his advice over the last few decades which has become the basis of investing common knowledge and format of long term investing both by novice and more seasoned investors. In essence understanding the advice of Mr. Buffett is a key to understanding the stock market.

Safety Marginsstock market 1

When it comes to investing one must understand the safety margin and risk that comes along with the action of investing. Buffett’s advice on the matter states that “If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety.” What does that mean? The most simplistic way to explain is to say that you are in a truck that is driving across a bridge. The weight limit of the bridge is 8000 pounds and your truck weighs 7990 pounds. If the bridge were only about ten feet off the ground, you’d feel fine about crossing the trek, however if the bridge were 6000 feet high, you might rethink crossing the bridge. Buffett has applied the same thinking toward investing. If the business isn’t worth the risk, no matter what the possible return could be on the investment, it just isn’t a wise investment.

The Value of a Company

The value of a company goes well beyond its stock price and overall net worth. The reasoning behind this is the longevity of a well established company that will continue on in generations to come. One of the more famous investment advice quotes by Warren Buffett says, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” This is some of the most practiced advice given by Warren Buffett because he has replicated this advice in his own career. Examples would be the companies owned by his company Berkshire Hathaway which owns such companies like Dairy Queen and GEICO. Buffett is a firm believer that a wonderful company is a company that is simplistic in the nature of its business and his ownership over such businesses follow suit with that principle. GEICO sells insurance, and Dairy Queen – ice cream. By understanding the base line purpose of how a company profits and operates is one of the best ways to understanding the stock market.

There isn’t any harm in knowing what you are investing in and how both the company and you are going to profit. Complex business models do not guarantee success, but simple business plans do when focused on the overall bottom line of how and what kinds of business is to be conducted.

The Direction of a Company is in Its Leadershipstock market 2

The direction of any company can be defined by the leadership. This is understandable when we look at recent changes in leadership over the last couple months as companies and their board of directors change CEO’s at a whim. Apple did it and saw an increase in projected revenue as well as overall direction of the company within the coming months. Investors were shocked yesterday as Target has revealed that the company is going in another direction, one without current president and CEO Gregg Steinhafel.

Warren Buffett’s advice while comical also holds some solid truth in the manner in which he looks at when investing in a company. “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” While Warren Buffett’s idea of idiots running companies may be a lot different from your definition, he is the fourth richest man in the world. Sometimes we must play second fiddle to those who may know more about corporate idiots than the corporate idiots we may have to deal with on a daily basis.

Understanding the stock market isn’t hard when you have advice being given freely to you like the bulk of us do from investing guru’s like Warren Buffett. While he may never give us his personal stock picks, he has given us the ability to make sound and educated decisions about potential stocks on our own. Like any parent to their child, the best way to get someone to learn and master any skill, is to let them practice and do it on their own. Understanding the stock market may not the easiest at first, but with some helpful advice and personal practice, great outcomes can be achieved with a little effort and a lot of determination.

 

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