Is Warren Buffet's Investment Strategy Suitable for Your Financial Profile?
Most investors are not as skilled with the financial markets as Warren Buffett, and may not be able to replicate his investment strategy of value investing. Buffett is one of the greatest investors of all time. He performs a great deal of due diligence and fundamental analysis before investing in a company.
Buffett’s value investing strategy is out of reach for many investors. However, investors can mimic his investing strategy by buying shares in Berkshire Hathaway, Inc. As an alternative, investors can follow Buffett’s own advice and invest in a stock index fund with low costs.
Buffett’s Value Investing
Buffett is known for his value investing style. This strategy seeks to find companies that are undervalued by the market and that can, therefore, be bought for a good price. Buffett believes that every company has an intrinsic value, which he defines as the amount of cash that can be taken out of a business during its remaining life. The difficulty is in calculating the intrinsic value. Buffett notes that this number is an estimate as opposed to a hard figure. The intrinsic value can change if interest rates move or if the amount of future cash flows shifts. Buffett looks at different fundamental financial ratios to determine the intrinsic value of a company.
If this intrinsic value is below the market value for the company, Buffett may explore it as an investment opportunity. He also uses other guidelines for investing. He sticks to businesses that make sense and that he understands. He does not reach for companies, such as those in the tech industry, that are outside his areas of expertise. Further, he looks for companies that have economic moats. A moat is essentially a competitive advantage that will allow the company to continue generating revenue into the future.
Obviously, the value investing style involves a great deal of analysis and subjectivity. Most investors do not have the time or energy to follow this approach.
Berkshire Class B Shares
There are good options for investors who want to mimic the value investing approach. The easiest way is to buy Class B shares in Berkshire Hathaway. Berkshire Hathaway is one of the largest companies in the world, with a market cap of $335 billion as of November 2015. The company has an enormous portfolio with a value of over $109 billion as of June 2015.
By buying shares in the company, investors are partially tracking Buffett’s enormous portfolio. There are a couple of caveats to this strategy. Berkshire Hathaway does not pay any dividends, even though there are stocks in his portfolio that distribute cash to shareholders. For example, the largest holding in the company’s portfolio is Wells Fargo & Co., which pays a dividend yield of 2.7% as of November 2015. Shareholders essentially miss out on this dividend.
Buying shares in the company also provides exposure to the large variety of businesses in which Berkshire Hathaway has invested. This may be a benefit, however, as many of the businesses are wildly successful in generating revenue and growth.
Buffett is a huge fan of low-cost index funds that track the market. He believes these funds are the easiest way for most investors to gain exposure to the market. In his 2014 shareholder letter, Buffett noted that the trustee of his estate should follow a very simple investment strategy. He writes that the trustee should invest 10% of the estate's cash in short-term government bonds, with the other 90% invested in a low-cost S&P 500 index fund. Buffett states that he believes this simple strategy will outperform the returns of even large institutional investors who use high-fee managers. This strategy is very simple and cheap for inexperienced investors to implement.