3 Things Warren Buffett Looks For While Investing In A Company
Ever wondered what makes Warren Buffett such a successful investor (and of course the 4th richest person in the world)? How his investments generated multi-fold returns despite market volatility and fluctuations? Read on to know about his investment mantras –
# Number 1 Intrinsic Value Of A Company
Warren Buffett is a strong proponent of Value Investing. He has often quoted that he is 85% Benjamin Graham (the godfather and founder of Value-based investing strategy). According to this approach, one should look for the intrinsic or true value of a company rather than worrying about only current numbers or performance metrics. It is important to look at a company in its wholeness.
Value investors like Warren Buffett ignore the demand and supply intricacies. They look for stocks which are priced unjustifiably low as compared to their intrinsic value. They believe that in the long run, the market will discover the true value of these quality stocks and their market value will shoot up.
Some metrics considered while deciding the intrinsic value of a company-
1.Return On Equity
ROE is the rate at which stockholders earn returns or income on their investment. It helps in analysing the performance of the company in comparison to other players. It is calculated by dividing the net income by the shareholder’s equity. Warren Buffett looks at the ROE for the last 5-10 years to analyse the true potential of a company.
2.Debt
Debt to Equity Ratio is another critical parameter. Buffett prefers companies with lesser debt as it indicates that earnings are being generated from the shareholder’s equity rather than borrowings. It is calculated by dividing the total liabilities with the shareholder’s equity. Higher is the value, lesser are the chances of Mr. Buffett investing in it. That is because a significant chunk of the earnings will go towards servicing the debt.
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3.Profit Margin
Warren Buffett’s style of investing is analysing the profit margin of companies (and growth in it) over a sustained time period. This margin is derived by dividing the net income with the net sales.
Value investing is not for you, if:
You are an emotional investor
Warren Buffett once said, “Only when you combine intellect with emotional discipline, do you get rational behaviour”. Value Investing follows the same principle. Emotions can adversely impact investment related decisions. Value investors do not get swept away by market sentiments but rather look at the true value of a stock. They also do not fall for the “growth trap” without understanding the history or intrinsic strength of the stocks.
You like to follow the herd
The value investing approach is not for those who like to follow the crowd. In his words, “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well”. In the long run, only inherently solid stocks (with a high intrinsic value) are going to fill the coffers.
Companies | Type | Bidding Dates | |
| Regular | Closes 23 Dec | ||
| Regular | Closes 23 Dec | ||
| SME | Closes 23 Dec | ||
| Regular | Closes 23 Dec | ||
| Regular | Closes 23 Dec |
#Number 2 Competitive Advantage
The fundamental basis of above-average performance in the long run is durable competitive advantage. A company which has substantial and sustainable competitive advantage over its competitors has Mr. Buffet’s attention. Classic example being his investment in Coca Cola which had a lion’s share of the market at that time. Such companies are able to grab a larger chunk of the market, enjoy customer loyalty and have pricing power. All these factors in combination help them to widen their profit margin in the long-run.
These companies have established a strong and credible brand name in the industry, reach out to more customers through their extensive distribution network and most importantly have a unique offering (whether product or service). They continuously invest in research and innovation to introduce new and better offerings.
As Warren Buffett puts it, “a good business is like a strong castle with a deep moat round it. I want sharks in the moat to make the business untouchable”. Invest in companies that have something different about them. Something that sets them apart. Any characteristic about the business which makes it hard for peers or competitors to replicate gives it a definite edge or an in other words, an “economic moat”. Wider is the moat, tougher for the competitors to take market share which will translate into higher profits for investors.
Words to remember –
Go for a company which has a unique product that can remain desirable for a long period of time.
Durability of competitive edge is equally important. For instance, technology has completely changed the idea of home entertainment. Gone are the days of renting VCDs. Even DTH companies are struggling to hold on to their customers. Online content platforms (YouTube, Netflix, Prime, etc.) are stealing the show these days.
#Number 3 : The “Buy and Hold “ Potential
In addition to being a value investor, Warren Buffett is known for his passion for the “buy and hold” approach. As he says, it is easier to predict what will happen 10 or 20 years down the line, rather than tomorrow or even next week. (because he invests in companies with durable competitive advantage).
What is Buy and Hold?
Buy and Hold Approach refers to an investment strategy wherein investors buy stocks or any other investment instruments and holds them over a long period of time, irrespective of market fluctuations or volatility. It falls under the ambit of passive investing as investors ignore stock price fluctuations or such other technical indicators.
He feels investments in stocks should not be for the purpose of capital gains in the near-term. It should be done with a view to create wealth in the long-run. Hence, investing in solid stocks is extremely important as only they will stand the test of time and multiple market cycles.
Example of investment done by Warren Buffett with this approach
His investment in Wrigley’s chewing gum is a classic example. He knew that irrespective of any technological upgradation in the future, the basic product would remain the same. It was not going to adversely influence the consumer’s gum chewing habits or preference. Hence, he was sure that the product would stand the test of time.
Warren Buffett held on to Wrigley’s share for a very long period of time and finally sold his stake to the company (Mars) and made multi-fold returns on his investments. The original investment of USD 2.1 billion grew to USD 23 billion at the time of sale.
Bonus! #Number 4 : The Circle of Competence
Warren Buffett has always emphasized on the importance of the circle of competence. To quote him, “never invest in anything that you don’t understand properly”. Hence, deep dive into the industry, its workings, relationship or dependence on global or economic factors along with the company’s background (including the credibility and stability of the management).
Conclusion
The “Oracle of Omaha” sticks to these investment guidelines. Incorporate them in your financial decisions and see the magic. But as the legend himself says, “The stock market is a device to transfer money from the impatient to the patient”. So, be in the game for the long term. Never forget –Slow and steady wins the race.
Happy Investing!
Disclaimer: The views expressed in this post are that of the author and not those of Groww.