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For several months investors have been facing one of the worst environments in decades: rising inflation, rising interest rates, threats of conflict, energy shortages and of course recession. The SP500, which alone represents up to 80% of the American economy, lost 17% in 2022, which is already impressive, but much worse, according to Vandary Search, the average portfolio of individual investors fell by 36%.
At this level, it's a serious crash when things go wrong; it's our convictions that are tested, and how do you react in these situations? For Warren Buffett, the stock market is the only place where people run away when the sales start. So, for beginners as well as experienced investors, let's refresh our memories on Buffett's principles that allow him to have very strong convictions.
The number one principle for Warren Buffett is obviously to invest in value, and he has been explaining to everyone what value is for 50 years. Here's a statement in a few seconds: if you think you'll earn 50 euros in 2030, then today you shouldn't invest more than 25 euros if you want a 10% return.
It's a simple application of the compound interest formula: the sum invested today, 25 euros, will become 50 euros in 2030. You've doubled your investment in 7 years. When you have several promises of cash at different times in the future, the present value is simply the sum of all these promises of cash, calculated at your current rate of return.
Value is universal, so we can apply it, for example, to a simple apple tree. The value of an apple tree is what you would be willing to pay at most today, and therefore intrinsically linked to what it will produce for you in the future. So there's no way around it; you must have an idea of the number of kilos of apples the apple tree will produce for you in the future.
There's no other way to deduce its present value. Warren Buffett has been explaining publicly for 50 years that you must have the same approach in the stock market: a stock is not fundamentally different from an apple tree. It's a share of a company that will produce something for you each year, and what the stock produces for you each year can be summarized as earnings per share.
For example, today Coca-Cola's earnings per share are around $2 each year. The role of an investor who wants to know if Coca-Cola is a good deal right now is simply to have an opinion on this $2 per year in the future and deduce a value for them in the present, in the same way as for an apple tree. From there, if the price offered by the market is above the value we just estimated, then it's too expensive for us.
On the other hand, if the price is lower than the value we just estimated, then we have a margin of safety. This margin of safety is one of Warren Buffett's primary concepts for having very strong convictions, because the greater the margin of safety you have between the estimated value and the price offered by the market, the more you can be wrong in your estimates and still make a profit.
To be right about your investment, if you want to have an opinion on future profits, well, it's recommended that you only invest in companies you understand. They call these companies that are part of your skill set. So, I'll give you my personal tip, for what it's worth, to know if a company is part of my skill set.
You're probably familiar with simulation video games like Football Manager or SimCity, and I simply ask myself the question: would I personally be able to develop one of these video games based on the business that interests me? And if I'm able to have a fairly clear idea of this Football Manager Business Edition streaming, then I consider streaming companies to be part of my skill set.
And even if the mechanics of this game only exist in my head, there are still players who come to me every year to explain how they played the game while reading the annual report. If you don't understand when the manager explains how he just played the game this year, well, maybe you simply don't understand the game.
Warren Buffett, all he wants is to find games that are terrible to play. A game is terrible when it's extremely simple and always the same player wins, someone who's known to have already won, to the point that others don't even want to play with them anymore. That's Warren Buffett's great specialty: identifying businesses where one player has such a competitive advantage that the game is won in advance, ideally for the next 10 or 20 years.
There are several known types of competitive advantages, such as monopoly, network effects, or the cost of switching. If you're interested, I detail about a dozen of them in another video on the channel. The idea today is to try to understand how Warren Buffett identifies his competitive advantages in the businesses he analyzes.
Well, he simply asks himself, "If I had to play a game against this company, if I had to create a competitor, what would pose the biggest problem for me in winning the game?" If we take In the streaming industry, and Netflix for example, it's clear that no competing company is afraid to try and get involved.
So, even though I feel like I understand the streaming industry and Netflix, when I ask myself about Netflix's competitive advantage— whether they've already won the game for the next 10 or 20 years— well, I can't answer that question. There's nothing obvious to me about saying that Netflix will win every time in the next 20 years.
But on the other hand, if I wanted to compete with Microsoft, I would probably have two major problems: I would need billions and billions to create an OS to compete with Windows, and even if it were satisfactory, even if I could sell it, probably no one would want to buy it because what's important for an operating system is the software made by other publishers that works with it, and on mine, there would be absolutely nothing.
I feel like... Knowing in advance that Microsoft will definitely win within the next 10 years, whereas I can't answer that question about Netflix, and so the next point Buffett will focus on to determine if his future profits are more or less secure should now seem obvious to you: he's going to bet on the future.
So you just need to read what management tells you, and if you understand the game, you'll quickly deduce whether he's a good or bad player. And not only can you have an opinion on whether he's good or bad, but you can also have an opinion on his motivations: Is he risking everything in this famous game?
Has he put his own money on the line, or is he just an employee? And when they make decisions for their company, is it just him and his family with their own money, or is it actually a team made up of two investment funds, sometimes even the government, around the table? You need to understand how the decision is made, and if There's definitely a business interest at the heart of this decision.
Identifying the potential for stupidity to avoid it seems relatively easy to me. A simple example, my personal opinion, but when I saw the CEO of Disney explain a few months ago that their strategy is now to have a political agenda in their entertainment works, and therefore to explain to more than half of their audience that they are no longer welcome to be Disney customers, I simply think that it's somewhere between stupid and suicidal.
Because in my mind, in this simulation of the entertainment business, that's not how you're going to win the game. But perhaps I haven't understood the game. The next step is simply to choose where you're going to allocate your resources, and for that, you simply need to have a list of all your investment alternatives.
Most people will include stocks, your real estate projects, obviously ETFs, but also your personal and professional projects. It's simply a list of all these ideas that you understand and that you think are worthwhile. They hold up because you have a great deal of certainty that they will be successful, and for each of these ideas, you put the result of your value calculation, the threshold from which you consider it a very good deal.
Then, from that point on, many of your ideas are simply excluded because the market price is above the value you expect. Unfortunately, this is almost always the case; you will often find most of your good ideas too expensive. It's for this same reason that the famous Zetf SNP 500, for which you can be certain it will still be around in 50 years simply because it has a self-cleaning mechanism, offers you absolute certainty of having something for several decades.
Often, it's this Zetf SNP 500 and personal or professional projects that end up at the top of the list as the obvious choices of the moment. But from time to time, the market will offer you a price that puts Coca-Cola or Berkshire Hathaway in the dust. At the top of the list, and at that moment, you'll finally be the person who thinks it's a sale and that people are crazy not to buy.
This incredible company is guaranteed to win every time in its business over the next 20 years. This is also because Warren Buffett has this kind of list with his best idea at the very top, as long as he doesn't diversify at the end. Well, if you subscribe to Warren Buffett's approach, you should start to understand that you're never supposed to sell because, ideally, you should only have businesses in your portfolio that you're more certain about than the TF SNP 500— businesses that you consider immortal and that bring you more than a 10% return.
So, the conclusion is that you should sell if you find a better idea or simply if the fundamentals of the business change. And fundamentals aren't exactly the balance sheet. The balance sheet will give you a financial picture of the business's health, but there can sometimes be declines in profits. which are purely circumstantial.
What you need to try to understand is whether the rules of the game have changed, whether the company's sustainable competitive advantage is ultimately eroding because a competitor has come up with a brilliant idea. Note that the rules of the game will now change, and the player you bet on is no longer certain of winning over the next 10 years.
So, there you have it: value, margin of safety, circle of competence, competitive advantage, management, compare alternatives, and sell when one of these parameters has changed. And that's simply the pillar of the Buffett approach, which he has been publicly repeating for 50 years. If you didn't enjoy this video, thank you for staying this long.
If you did enjoy this video, thank you for subscribing and commenting, and I wish you all a wonderful weekend. See you soon!
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