Buffett: Buy Stocks Like Real Estate

 | Mar 03, 2014 | 4:30 PM EST
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At this time every year, I read and dissect Warren Buffett's annual letter to Berkshire Hathaway (BRK.A, BRK.B) shareholders. Aside from Buffett's usual investing wisdom, observations of Berkshire's businesses and other folksy comments, there is always a simple yet crucially important lesson on the stock market.

This year it was the value of buying stock like you would real estate. Quite frankly, and humbly, it's something I've been saying all along: Buy stocks like you would a house.

When you buy a house, what do you do? First, examine the price and determine if it seems like a good value. Inspect the house and appraise its value. From there, examine the neighborhood and surrounding area to make sure it also justifies what you are looking for.

Now transpose this task to stock selection. If you are investing, examine the company and see if the price makes sense. Perhaps look at the current stock price vs. the historical price. If the business seems to be in similar shape but for some reason it's being priced at a fraction, perhaps an opportunity is there. Next, examine the "neighborhood," or the industry, to become familiar with the space. If you like it and determine that your stock is a "quality house" on the block, buy it.

Once you make a purchase, the real value of thinking like a real estate buyer kicks in. Let's assume you purchase a house for $250,000. If the following month, the house next door sells for $200,000, do you panic and sell yours? Or if that house sells for $300,000, do you rush to sell yours out of joy? The answer to both is, probably not. The same rationale should be applied to stock investing, Buffett says. Each day, the market gives you a price at which you can buy or sell your asset. As long as you've bought wisely for a sensible price, you shouldn't care an iota as to the movement in the share price.

The daily movement in stock prices does not signify a similar movement in intrinsic value. Daily quotations should be ignored except when allowing you to sell at a premium or buy at a discount. Aside from that, the prices that Mr. Market quotes every minute are senseless noise.

Stock investing is that simple, really. The difficulty is in the execution. But if you learn how to buy right, sit still and take advantage of prices, you will be well ahead of the pack.

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