Warren Buffett’s 3 Cornerstones of Sound Investing

It can be difficult to get out of the gambler mindset – because gambling is addictive. It’s also one of the most important things you can do to preserve and grow your wealth.

The stock market isn’t a casino – far from it. Rather, the stock market is a place where people with excess capital (investors) go to purchase pieces of businesses.

Thinking of a stock as a small piece of a business dispels the gambler myth about the market.

When you buy a stock (even just 1 share), you are buying fractional ownership of a business.

It’s even easier to remain committed to your stocks when you can actually see or use their products.

That’s because a link between the digital numbers in your investment account and the real world business is established.

This makes it obvious how wrong the idea that the stock market is a giant casino really is.

If you own shares of PepsiCo, Inc. (NYSE:PEP), you know you are profiting every time you see someone drinking a Pepsi or eating a bag of Lay’s potato chips.

Similarly, if you own McDonald’s Corporation (NYSE:MCD)‘s shares, you benefit every time someone eats at McDonald’s.

While it’s true we don’t get tiny checks every time someone drinks a Pepsi or eats a Big Mac, the real earnings from these purchases do pass through to the business – and the business passes that value along to shareholders in one of two ways:

1. If earnings rise, the share price will (eventually) rise

2. Through dividends

That’s one of the many reasons I’m such an advocate of Dividend Growth Investing; it creates a link between rising company value and rising dividend income.

When McDonald’s makes more money, it pays a larger dividend. This makes the connection between the business and your investment very clear.

McDonald’s Corporation (NYSE:MCD) (and every other business) can only pay rising dividends if they make more money every year (or nearly every year).

Dividend growth investing places the emphasis on the business. If a PepsiCo, Inc. (NYSE:PEP) or McDonald’s Corporation (NYSE:MCD) stops growing, it will be unable to pay rising dividends in a few year – there is no escaping the cold hard reality that dividends come from earnings. To pay increasing dividends, you must have increasing earnings.

To have increasing earnings for decades, a business must have a strong and durable competitive advantage.

Dividend growth investors don’t look to gamble on ‘the next big thing’. Instead, we look for businesses that have the ability to pay increasing dividends.

This puts the investor’s focus right where Warren Buffett says it should be – on the business.

There is a select group of stocks that have paid increasing dividends for 25+ consecutive years in a row. This group is called the Dividend Aristocrats. Click here to see all 50 Dividend Aristocrats.

To be a Dividend Aristocrat a business must have a strong competitive advantage – how else could it pay increasing dividends for 25+ years? It should come as no surprise that the Dividend Aristocrats index has substantially outperformed the market over the last decade.

Source:  S&P Dividend Aristocrats Fact Sheet

If investors looked at dividend increases rather than stock prices, investors in general would be far better off.

Stock prices are distractions that can deter you from the goal of investing in great businesses with favorable growth prospects.

It’s important to view stock prices (and market fluctuations) in the correct way.