How to Build Wealth Like Warren Buffett 

  Lou Simpson’s Five Investment Principles 

  1. Think independently. “We try to be skeptical of conventional wisdom,” he 
  says, “and try to avoid the waves of irrational behavior and emotion that peri- 
  odically engulf Wall Street. We don’t ignore unpopular companies. On the 
  contrary, such situations often present the greatest opportunities.” 

  2. Invest in high-return businesses that are run for the shareholders. “Over the 
  long run,” he explains, “appreciation in share prices is most directly related to 
  the return the company earns on its shareholders’ investment. Cash flow, 
  which is more difficult to manipulate than reported earnings, is a useful addi- 
  tional yardstick. We ask the following questions in evaluating management: 
  Does management have a substantial stake in the stock of the company? Is 
  management straightforward in dealings with the owners? Is management 
  willing to divest unprofitable operations? Does management use excess cash 
  to repurchase shares? The last may be the most important. Managers who run 
  a profitable business often use excess cash to expand into less profitable 
  endeavors. Repurchase of shares is in many cases a much more advantageous 
  use of surplus resources.” 

  3. Pay only a reasonable price, even for an excellent business. “We try to be dis- 
  ciplined in the price we pay for ownership even in a demonstrably superior 
  business. Even the world’s greatest business is not a good investment,” he con- 
  cludes, “if the price is too high. The ratio of price to earnings and its inverse, 
  the earnings yield, are useful gauges in valuing a company, as is the ratio of 
  price to free cash flow. A helpful comparison is the earnings yield of a com- 
  pany versus the return on a risk-free long-term United States Government 
  obligation.” 

4. Invest for the long-term. “Attempting to guess short-term swings in individual 
  stocks, the stock market, or the economy,” he argues, “is not likely to produce 

  consistently good results.Short-term developments are too unpredictable.

On   the other hand, shares of quality companies run for the shareholders stand an 

  excellent chance of providing above-average returns to investors over the long 

  term.Furthermore, moving in and out of stocks frequently has two major dis- 

  advantages that will substantially diminish results: transaction costs and 

  taxes.Capital will grow more rapidly if earnings compound with as few inter- 

  ruptions for commissions and tax bites as possible.” 

5. Do not diversify excessively. “An investor is not likely to obtain superior 
  results by buying a broad cross-section of the market,” he believes. “The more 
  diversification, the more performance is likely to be average, at best. We con- 
  centrate our holdings in a few companies that meet our investment criteria. 
  Good investment ideas — that is, companies that meet our criteria — are dif- 
  ficult to find. When we think we have found one, we make a large commit- 
  ment. The five largest holdings at GEICO account for more than 50% of the 
  stock portfolio.” 

  Source: The Warren Buffett CEO by Robert P. Miles