How Warren Buffett Picks Stocks: 3 Winning Tips

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Buffett’s response to these investing frenzies is to invest in what you know. While you probably don’t know how a computer chip works or why Intel makes computer chips that people want to buy, you probably know, for instance, why Coca-Cola (NYSE:KO) is such a popular drink: It tastes good and the company has exceptional marketing. Thus, Coca-Cola falls within your circle of competence even if you don’t know the company’s secret formula. All you need to know is why the company is successful, and you can postulate with relative certainty that this success will continue into the future.

Investing in companies that make simple products that you understand may be boring, but it is a winning approach that can generate a lot of value over time.

2. Buy wonderful companies at a fair price

The full saying is that it is better to buy a wonderful company at a fair price than a fair company at a wonderful price. When you are investing, you find value not just by looking at the numbers but by looking at intangible features as well such as management. A company that is well managed and that has a reputation for providing a quality product is worth more than a company lacking these qualities. The former company is positioned to take market share from the latter, and it is better positioned to withstand economic weakness. As a result, from a long-term perspective, it is better to pay a higher price-to-earnings ratio for the shares of a high-quality company than to pay a low price-to-earnings ratio for a low-quality company.

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