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Warren Buffett’s #1 Rule in Investing: How Can Investors Apply it?

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close-up photo of investor Warren Buffett
close-up photo of investor Warren Buffett

Written by Kay Ng at The Motley Fool Canada

Warren Buffett’s number one rule to investing is to “never lose money.” How can investors go about applying that rule when they start investing in stocks?

Warren Buffett is one of the best investors of our times and he’s a big fan of buying wonderful businesses, investing at a margin of safety, and earning dividends. When you seek to invest like Mr. Buffett, you should get more impressive returns than others who blindly buy and sell stocks based on volatile stock prices.

Canadian Western Bank (TSX:CWB) is a good example for this discussion.

A wonderful business paying a healthy dividend

In the past 10 years, the regional bank increased its earnings per share by about 5.7%. In this period, it diversified away from Alberta, a resource-rich province whose economic activities are more cyclical. Additionally, it experienced a bit of a setback during the COVID-19 pandemic. So, the 5.7% earnings growth rate was pretty good given what it has been through.

Now, its loan portfolio is primarily in British Columbia (33% of its loans), Alberta (31%), and Ontario (24%). While the bank still has meaningful exposure to Alberta, only about 1.3% of its loans are directly in oil and gas production businesses.

Canadian Western Bank is a safe dividend stock. It has maintained or increased its dividend every year since 1992. Its 10-year dividend-growth rate is about 8%. Its 2022 payout ratio is estimated to be about 31%, which is lower than its big Canadian bank peers’ payout ratios that are normally in the 45-50% range. It makes sense that the smaller bank has a bigger margin of safety for its dividend because of its more cyclical earnings. This kind of earnings also result in a more volatile stock.

The bank is still a wonderful business, though, because it has increased its earnings and kept its dividend steadily increasing in the long run. At the recent quotation, the dividend stock provides a decent yield of approximately 3.7%.

Is there a margin of safety for the bank stock?

At $32.16 per share at writing, the cheap bank stock trades at a discount of roughly 30% from its long-term normal valuation. If this valuation gap closes over the next three to five years, it will drive exceptional price appreciation. Simultaneously, this material margin of safety provides an addition layer of safety for CWB’s long-term investors’ capital.

The Foolish investor takeaway

Warren Buffett encourages investors to focus on never losing money. That’s super important to understand before they reach out for higher returns which often come with higher risk.

As a regional bank that still has considerable exposure to Alberta (and the economic health of the province will directly impact CWB’s bottom line), there’s no doubt the bank stock is higher risk. However, in the grand scheme of things, the company has demonstrated its ability to persistently grow its earnings in the long run, which has supported a healthy and growing dividend. Importantly, the stock is undervalued today and pays a decent dividend for patient investors to wait for its return to fair valuation. CWB should easily be a $50 stock over the next few years.

The post Warren Buffett’s #1 Rule in Investing: How Can Investors Apply it? appeared first on The Motley Fool Canada.

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The Motley Fool has no position in any of the stocks mentioned. Fool contributor Kay Ng owns shares of Canadian Western Bank.

2022

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