Buffett has a remarkable ability to spot high-yielding equities. Between 1965 and 2020, Berkshire Hathaway, the holding company Buffett runs, produced a compound annual return of 20%. That’s almost double the S&P 500’s 10.2% annual growth rate over the same period.
Fortunately for investors, Buffett is a fan of sharing his methods with the public. In early 2008, he described four characteristics that he and Charlie Munger, Berkshire’s other leader, use to assess investable firms.
The following sections offer a deeper look at those four traits and how you might use them in your own investing.
1. A business we understand
Buffett has emphasized the importance of investing within your area of expertise for a long time. The following are some reasons why you should invest in a firm where you have basic knowledge:
- You have a deeper appreciation of the firm’s assets and liabilities.
- You’ll be able to make better, faster judgments and decisions if you have new information.
- You are more invested in the situation. Your position isn’t simply a possibility that you hope will be successful; it’s a company you like to watch.
2. Favorable long-term economics
The favorable future economics boil down to excellent return on investment today, as well as a substantial competitive edge to safeguard those gains over time. The advantage may be the industry’s most cost-effective structure or a brand that is adored by people around the world.
Whatever the benefit, it must be sustainable. A lasting competitive advantage that is easy to copy or reverse fails the test.
This is one of the reasons why Buffett prefers industries that are more stable. Change, whether it’s in legislation, demand, or technology, may erode competitive advantages in ways that are difficult to anticipate.
3. Able and trustworthy management
Individual investors are hard-pressed to assess the trustworthiness of corporate leaders in the absence of a scandal. However, you may assess a leadership team’s capacity, and often its success and culture, by looking at the company’s performance and culture. You should consider:
- Has there been a clear and consistent strategy for expanding the company?
- Have they met the organization’s stated strategic objectives?
- What has the company’s track record in recessions been?
- How does the leadership team maintain and improve the company’s competitive edge?
- How has leadership coped with the company’s flaws?
- What do the workers think of their bosses?
4. Sensible price tag
Buffett is a value investor, as he invests in high-quality firms when the price is less than the firm’s underlying worth.
Buffett increased his stake in Apple by buying 3.7 million shares of the company shortly before it fell during the first quarter of 2022, as tech stock prices were declining. Berkshire Hathaway’s portfolio was already dominated by the iPhone manufacturer.
Berkshire Hathaway’s cash on hand was already $144 billion before the tech sell-off. So Warren Buffett could have purchased more Apple stock last year if he wanted to, but he did not.
Buffett’s profit margins are an intriguing example of his refusal to be deterred by market volatility.