Warren Buffett has a knack for finding high-return stock investments. Operated by the holding company Buffett from 1965 to 2020, Berkshire Hathaway, yielded a compound annual profit of 20%.almost double S&P 500has an annual growth rate of 10.2% over the same time frame.
Fortunately for the investment community, Buffett likes to share his methods with the masses. In early 2008, he outlined his four characteristics that he and Berkshire leader Charlie Munger use to identify investable companies.
Charlie and I are looking for companies that: b) Advantageous long-term economy; c) Competent and reliable management. d) Reasonable price tag.
Below, we’ll take a closer look at these four characteristics and how you can apply them to your investments.
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1. Business as we understand it
Buffett has long voiced the importance of investing within your capabilities. Investing in a company you understand has the following benefits:
- You have a better understanding of the company’s strengths and weaknesses.
- Receiving new information allows you to make better and faster decisions and judgments.
- You are more connected to your investment. Your position is more than you hope to make profit. It’s a business you enjoy following.
2. Good long-term economy
A good long-term economy boils down to strong returns on today’s invested capital, plus significant competitive advantages to protect those returns over the long term. Advantage is the industry’s most efficient cost structure and a brand loved by consumers around the world.
Whatever the advantage, it should be permanent. A competitive advantage that can be easily copied or deconstructed will not pass the long-term test.
This is one reason why Buffett prefers stable industries to fluid ones. Changes in regulation, demand, or technology can undermine competitive advantage in ways that are difficult to predict.
3. Competent and reliable management
Without scandals, it’s difficult for individual investors to assess the credibility of a company’s leaders. Questions to investigate are:
- Is management consistent and disciplined about growth initiatives?
- Have they implemented their declared strategic priorities?
- How has the company fared during the recession?
- How does management protect and enhance the company’s competitive advantage?
- How did management address the company’s weaknesses?
- What do employees say about their leaders?
4. Conscientious price tag
Buffett is a value investor. If the price tag is lower than the company’s intrinsic value, he invests in a quality business.
As an example, when tech stocks fell in the first quarter of 2022, Buffett bought 3.7 million shares. appleThe iPhone maker was already the largest player in Berkshire Hathaway’s portfolio.
Notably, Berkshire Hathaway’s cash reserves reached $144 billion before the technology sale. So while Buffett could have easily bought Apple stock last year, he chose not to.
In an interview with CNBC, Buffett admitted to buying Apple after it fell. He also said he would have bought more if the stock hadn’t recovered.
This aspect of Buffett’s approach is especially important now that the S&P 500 is flirting with a 14% annual decline. The recession may have caused the stock prices of some of your favorite stocks to fall as well.
keep it simple
Buffett likes to invest in great companies with great leaders at low prices. Notably, he can also explain in one sentence why a company is investable. His clarity is as inspiring as his method.
There is value in defining your own investment approach in clear, simple terms. It helps you stay focused and make more consistent decisions. If you want to be as successful as Buffett and beat the long-term returns of the S&P 500, you need that focus.
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Catherine Bullock has no positions in any of the stocks mentioned.The Motley Fool has positions in and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: Berkshire Hathaway (B shares) long $200 January 2023 call; Apple long March 2023 $120 call; Hathaway (B shares) Jan 2023 $200 short put, Berkshire Hathaway Jan 2023 $265 short call (B shares), and Mar 2023 Apple $130 short call. The Motley Fool’s U.S. headquarters has a disclosure policy.
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