A:

Investors have long praised Warren Buffett’s ability to pick which companies to invest in. Lauded for consistently following value investing principles, Buffett has accumulated a fortune of over $60 billion dollars over the decades. He has resisted the temptations associated with investing in the “next big thing”, and has also used his immense wealth for good by contributing to charities.

Understanding Warren Buffet starts with analyzing the investment philosophy of the company he is most closely associated with: Berkshire Hathaway. The company has a long-held and public strategy when it comes to acquiring shares: the company should have consistent earning power, good return on equity, capable management, and be sensibly-priced.

Buffett belongs to the value investing school, popularized by Benjamin Graham. Value investing looks at the intrinsic worth of a share rather than focusing on technical indicators, such as moving averages, volume or momentum indicators. Determining intrinsic worth is an exercise in understanding a company’s financials, especially official documents such as earnings and income statements.

How has the company performed?

Companies that have been providing a positive and acceptable return on equity (ROE) for many years are more desirable than companies that have only had a short period of solid returns. The longer the number of years of good ROE, the better.

How much debt does the company have?

Having a large ratio of debt to equity should raise a red flag because more of a company’s earnings are going to go toward servicing debt, especially if growth is only coming from adding on more debt.

How are profit margins?

Buffett looks for companies that have a good profit margin, especially if profit margins are growing. As is the case with ROE, examine the profit margin over several years to discount short-term trends.

How unique are the products sold by the company?

Buffett considers companies that produce products that can easily be substituted to be riskier than companies that provide more unique offerings. For example, an oil company’s product – oil – is not all that unique because clients can buy oil from any number of other competitors. However, if the company has access to a more desirable grade of oil – one that can be refined easily – then that might be an investment worth looking at.

How much of a discount are shares trading at?

This is the crux of value investing: finding companies that have good fundamentals, but are trading below where they should be. The greater the discount, the more room for profitability.

Buffett is also known as a buy-and-hold investor. He is not interested in selling stock in the near-term to realize capital gains; rather, he chooses stocks that he thinks offer good prospects for long-term growth. This leads him to move focus away from what others are doing, and instead look at whether the company is in the position to make money.

RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  3. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  4. How can EV/EBITDA be used in conjunction with the P/E ratio?

    Because they provide different perspectives of analysis, the EV/EBITDA multiple and the P/E ratio can be used together to ... Read Full Answer >>
  5. How can a company reduce the unsystematic risk of its own security issues?

    Companies can reduce the unsystematic risk of their own security issues simply by doing the most effective job possible of ... Read Full Answer >>
  6. How can I find net margin by looking a company's financial statements?

    In finance and accounting, financial statements represent the fundamental means of analyzing a company's financial position, ... Read Full Answer >>
Related Articles
  1. Stock Analysis

    How Warren Buffett made Berkshire Hathaway a World-beater

    It would almost be easier to list the industry sectors in which Omaha-based Berkshire Hathaway Inc. (NYSE:BRK.A) doesn’t turn gargantuan profits.
  2. Active Trading

    Warren Buffett: How He Does It

    We look at the Sage of Omaha's methodology for evaluating value stocks.
  3. Investing Basics

    Think Like Warren Buffett

    They don't call him "The Oracle" for nothing. Learn how Buffett comes up with his winning picks.
  4. Active Trading

    What Is Warren Buffett's Investing Style?

    Learn the main principles that Warren Buffet uses in assessing a company. His take on value investing may surprise you.
  5. Insurance

    Warren Buffett: The Road To Riches

    Find out how he went from selling soft drinks to buying up companies and making billions of dollars.
  6. Technical Indicators

    4 Ways to Find a Penny Stock Worth Millions

    Thinking of trading in risky penny stocks? Use this checklist to find bargains, not scams.
  7. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  8. Investing Basics

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  9. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
RELATED TERMS
  1. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!