Warren Buffett is considered one of the most successful investors of all time.
He started investing in stocks at age 10 and became a millionaire in his early 30s, when he started buying shares of Berkshire Hathaway at $7.60 a share. Today, Berkshire trades at around $465,000 and Buffett has a net worth of $107 billion.
Buffett is famous for his approach to buying large amounts of blue-chip companies with undervalued prospects and strong management. He then holds those stocks for years, if not decades. The secret to his success, he says, is following two rules:
“Rule #1: Never lose money. Rule #2: Never forget rule #1.”
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But there are three lesser-known tactics that Buffett used build your fortune that savvy investors might want to borrow – even if they sometimes go against his more famous investment strategies.
1. Sell put option
You would think that someone like Buffett seems to be devoted to blue-chip stocks would stay away from complex derivatives, but you’d be wrong.
Throughout his investing career, Buffett has utilized the advanced options trading technique of selling bare put as a hedging strategy. In fact, in Berkshire Hathaway’s 2007 annual report, the company admitted that it had 94 derivatives contracts that generated $7.7 billion in premiums during the year.
This strategy involves selling an option where you promise to buy a stock with a specific strike price lower than its current value at some point in the future. This immediately gives you money from selling the option. If the stock price doesn’t fall, you keep the money.
If the price falls below the strike price, you buy the stock at a lower price than you would have paid at the time you sold the option, with the proceeds from the option sale further reducing the cost basis. your. This is a good strategy for a stock you don’t mind owning in the first place. In 1993, Buffett used put options to pocket nearly $7.5 million in earnings while he waited for Coca-Cola’s stock price to drop.
This option is considered “naked” because you don’t yet have another option to buy the stock, such as short selling shares of the same stock to cover your purchase costs.
But keep in mind that this involves risk, which is not something a new investor should try on their own.
2. Invest in small cap stocks
When you’re throwing in billions of dollars of cash, buy shares of promising emerging companies won’t work. Shares of small-cap growth stocks of companies typically worth $300 million to $2 billion will simply move too much if the Oracle of Omaha makes a large enough purchase to worthy of his time.
“I have to go find elephants,” Buffett once said when discussing his investment options. “Maybe elephants are not as attractive as mosquitoes. But that’s the universe I have to live in.”
Of course, that’s not always the case. Buffett started his career primarily investing in small-cap companies. He invested more than half of his net worth in GEICO – when it was still relatively small – in 1951 at the age of 20.
One reason the so-called “mosquito” is attractive is that the stock exhibits the highest growth in the early days of a company’s operations. But today, just because those little outfits are forbidden to Buffett doesn’t mean you can’t go after them.
3. Cut losses when necessary
Buffett’s “buy and hold” approach doesn’t extend to never admitting that even he makes mistakes sometimes. When a loss occurs at a well-managed company, it is a sign that the economics of that business may have changed in a direction that will generate losses for a long time to come.
As for Buffett, his big mistake recently was investing in airline companies. Berkshire Hathaway used to own shares in all four major US airlines: Delta, American Airlines, Southwest and United. Although he only added these companies to his list in 2016, by the end of 2020 he has eliminated them all — at a relatively large loss.
Buffett takes responsibility for the failed strategy, but he clearly doesn’t see a future in the airline industry and has even gone so far as to call the industry a “bottomless pit.”
“We are not going to fund a company where we think it will cost money in the future,” he said at the time.
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This article is for information only and should not be construed as advice. It is provided without warranty of any kind.