Warren Buffett, nicknamed the Oracle of Omaha, is one of the most successful investors of the last century. But how does he do what does?
Buffett’s style of investing is known as value investing, and is, in fact a really simple concept. The idea is to buy stock in an excellent business for a fair price. It doesn’t get anymore complex than that! Buffett is not using fancy derivative instruments, or hedging his positions, or shorting stock. He is just buying quality businesses.
How do you find a quality businesses?
The simple answer to this is to read, a lot. Warren Buffett reportedly spends most of his day reading. In fact, many of the great CEOs of our time (Bill Gates, Jeff Bezos) advocate reading as the best way to gain knowledge.
There are no simple formulas for finding great businesses. It all comes down to understanding as much about the business as you possibly can. This comes from reading deeply and reading widely. However, there are a few general concepts that can set you in the right direction.
- Controlled debt levels – businesses who are weighed down by debt will not be able to return value to the shareholders.
- Honest management – managers of businesses should not act like politicians. That is the politicians job. You want to be able to trust that managers will act in your best interests.
- A solid history of strong earnings. Buffett generally wants to see at least a decade worth of solid earnings growth. This should be at least 10%, but 15% is most desirable.
- Simple business – this will make it easier for you to understand, and easier for the managers to manage. Overly complex businesses are difficult to grow, and difficult to adapt when times get tough.
What is a reasonable price?
A reasonable price is anything below what we call the ‘intrinsic value’ of the business. Put simply, the intrinsic value is the present value of all of the cash flows the business will provide to investors going into the future. This should include dividends and capital gains. If you can find a company trading significantly below its intrinsic value, and that company is a solid business, then it is likely that it is a good investment.
Calculating intrinsic value is a more difficult topic. It involves predicting the future performance of the business. This is made easier if you follow the advice above in selecting a quality business.
We are lucky, because every year Warren Buffett writes a letter to shareholders of his company, Berkshire Hathaway. Over the last several decades, Buffett has provided immense value in these letters, and if you read them you will be able to gain a lot of knowledge about how he analyses businesses for investment. Luckily, the letters have been compiled into a book for us, separating them into the different areas of business to make them easy to navigate. The book is linked below. I encourage you to read it, to understand if Buffett’s investing style is for you.