Warren Buffett’s Investment Strategy

Warren Buffett is known as both a savvy businessman and generous philanthropist. He's one of the world’s richest people, consistently ranking high on the Forbes list of billionaires. His net worth was listed at a bit more than $130.7 billion as of July 2024.

He's probably best known for being one of the world’s most successful investors. Warren Buffett’s investment strategy has reached mythical proportions. He subscribes to several important tenets and an investment philosophy that's widely followed around the globe. So, what are the secrets to his success?

Key Takeaways

Warren Buffett is one of the wealthiest people in the world, amassing his fortune through a successful investment strategy.
Buffett follows the Benjamin Graham school of value investing which looks for securities with prices that are unjustifiably low based on their intrinsic worth.
Buffett looks at companies as a whole rather than focusing on the supply-and-demand intricacies of the stock market.
Some factors Buffett considers include company performance, company debt, and profit margins.
Other considerations for value investors like Buffett include whether companies are public, how reliant they are on commodities, and how cheap they are.

Warren Buffett: A Brief History

Warren Buffett was born in Omaha in 1930. He developed an interest in the business world and in investing at an early age, including the stock market. Buffett started his education at the Wharton School at the University of Pennsylvania before moving to the University of Nebraska where he received an undergraduate degree in business administration. He later went to the Columbia Business School where he earned his graduate degree in economics.

Buffett began his career as an investment salesperson in the early 1950s and he formed Buffett Associates in 1956. He was in control of Berkshire Hathaway less than 10 years later in 1965. Buffett announced his plans to donate his entire fortune to charity in June 2006. He and Bill Gates then announced in 2010 that they had formed the Giving Pledge campaign to encourage other wealthy individuals to pursue philanthropy.

Buffett’s Investment Philosophy

Buffett follows the Benjamin Graham school of value investing. Value investors look for securities with prices that are unjustifiably low based on their intrinsic worth. There isn’t a universally-accepted method to determine intrinsic worth but it’s most often estimated by analyzing a company’s fundamentals. A value investor searches for stocks that are believed to be undervalued by the market or that aren't recognized by the majority of other buyers.

Buffett takes this value investing approach to another level. Many value investors don't support the efficient market hypothesis (EMH), a theory that suggests that stocks always trade at their fair value. This makes it harder for investors to buy stocks that are undervalued or to sell them at inflated prices. They do trust that the market will eventually start to favor those quality stocks that were undervalued for a time.

Warren Buffett has continuously stressed the importance of investing in yourself as a means to success. This includes making prudent financial choices as well as increasing your knowledge in the areas in which you seek to take part.

Buffett isn’t concerned with the supply-and-demand intricacies of the stock market. He’s not really concerned with the activities of the stock market at all. This is the implication in his famous paraphrase of a Benjamin Graham quote: “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”

He looks at each company as a whole so he chooses stocks based solely on their overall potential as a company. Buffett doesn’t seek capital gain by holding these stocks as a long-term play. He wants ownership in quality companies that are extremely capable of generating earnings.

Buffett isn’t concerned when he invests in it whether the market will eventually recognize a company's worth. He's concerned with how well that company can make money as a business.

Buffett's Investment Tips

Buffett has shared his philosophies through some outstanding and thought-provoking tips over the years.

1. Wait...Then Pounce

Buffett advises taking a deep breath and a step back when you find a company in which you want to invest. He suggests giving the stock time to achieve a reasonable valuation, then moving when the market corrects.

2. Stay the Course

So you've breathed, you've waited, and now it's time to move. Buffett suggests that you want to resist panicking at this point and selling your holdings when they falter...and at some point, they will. Don't sell. Buy.

"Just keep buying," he said in a CNBC interview. "American business is going to do fine over time, so you know the investment universe is going to do very well."

3. Pick Businesses, Not Stocks

Always, always weigh and analyze the business behind a stock. Try to focus on businesses you understand and of which you have some knowledge. This will help you assess where a company is going, not just where it's been and where it is at present.

Buffett once famously took passes on Google and Amazon because he admitted that he didn't possess firm knowledge of the Internet industry so he found it difficult to analyze its stocks.

This tip goes hand-in-hand with having patience. Educate yourself if you spot an interesting opportunity in a field that you're not entirely familiar with. Analyze the balance sheets. Take time to learn.

Another priceless Buffett advisory comment is that you should plan to own a stock for at least 10 years, if not longer, keep in mind that a business will have time to evolve. "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes," he said in his 1996 letter to Berkshire Hathaway shareholders.

Buffett’s Methodology

Warren Buffett finds low-priced value by asking himself some questions when he evaluates the relationship between a stock’s level of excellence and its price. But keep in mind that these aren't the only things he analyzes. They make a brief summary of what he looks for in his six-step investment approach.

1. Company Performance

Return on equity (ROE) is sometimes referred to as the stockholder’s return on investment. It reveals the rate at which shareholders earn income on their shares. Buffett always looks at ROE to see whether a company has consistently performed well when compared to other companies in the same industry.

ROE is calculated as follows:

ROE = (Net Income ÷ Shareholder’s Equity) X 100

Looking at the ROE in just the last year isn’t enough. An investor should view it from the past five to 10 years to analyze historical performance.

2. Company Debt

The debt-to-equity (D/E) ratio is another characteristic Buffett considers carefully. He prefers to see a small amount of debt with earnings growth being generated from shareholders’ equity rather than borrowed money.

The D/E ratio is calculated as follows:

Debt-to-Equity Ratio = Total Liabilities ÷ Shareholders' Equity

This ratio shows the proportion of equity and debt the company uses to finance its assets. The higher the ratio, the more debt is financing the company rather than equity. A high debt level compared to equity can result in volatile earnings and large interest expenses. Investors sometimes use only long-term debt instead of total liabilities in the above calculation for a more stringent test.

3. Profit Margins

A company’s profitability depends not only on having a good profit margin but also on consistently increasing it. This margin is calculated by dividing net income by net sales. Investors should look back at least five years for a good indication of historical profit margins.

A high profit margin indicates that the company is executing its business well. Steadily increasing margins means that management has been extremely efficient and successful at controlling expenses.

4. Is the Company Public?

Buffett typically considers only companies that have been around for at least 10 years. Most of the technology companies that have had their initial public offerings (IPOs) in the last decade wouldn’t appear on his radar as a result. He’s said that he doesn’t understand the mechanics behind many technology companies and only invests in businesses that he fully comprehends.

Value investing requires identifying companies that have stood the test of time but are currently undervalued.

Value investing focuses on a company’s financials, whereas technical investing looks at a stock’s price and volume and how the price has moved historically.

Never underestimate the value of historical performance. This demonstrates the company’s ability or inability to increase shareholder value. But keep in mind that a stock’s past performance doesn't guarantee future performance.

The value investor’s job is to determine how well the company can perform in the future. Determining this is inherently tricky but Buffett is clearly very good at it.

One important point to remember about public companies is that the Securities and Exchange Commission (SEC) requires that they file regular financial statements. These documents can help investors analyze important company data, including current and past performance, so they can make important investment decisions.

5. Commodity Reliance

You might initially think that this question is a radical approach to narrowing down a company but Buffett sees it as an important one. He tends to shy away from companies whose products are indistinguishable from those of their competitors, as well as those that rely solely on a commodity such as oil or gas... but not always.

Buffett sees little that sets that company apart if it doesn't offer anything different from another firm within the same industry. Any characteristic that's hard to replicate is what Buffett calls a company’s “protective moat,” giving it a competitive advantage. The wider the moat, the tougher it is for a competitor to gain market share.

6. Is It Cheap?

This is the kicker. Finding companies that meet the other five criteria is one thing but determining whether they're undervalued is the most difficult part of value investing. That makes it Buffett’s most important skill.

An investor must determine a company’s intrinsic value by analyzing several business fundamentals, including earnings, revenues, and assets. A company’s intrinsic value is usually higher and more complicated than its liquidation value, which is what a company would be worth if it were broken up and sold today.

The liquidation value doesn’t include intangibles that aren't directly stated on the financial statements, such as the value of a brand name. When Buffett determines the intrinsic value of the company as a whole, he then compares it to its current market capitalization: its current total worth or price.

Sounds easy, doesn’t it? Buffett’s success depends on his unmatched skill in accurately determining this intrinsic value. We can outline some of his criteria but we have no way of knowing exactly how he gained such precise mastery at calculating value.

Buffett’s Top Holdings

It's possible to see which stocks Buffett has signed off on as good investments based on regulatory filings from his public holding company, Berkshire Hathaway (BRK.A). As of July 2024, these included:

Apple, Inc. (AAPL)
Bank of America (BAC)
American Express (AXP)
Chevron (CVX)
Coca-Cola (KO)
Kraft Heinz (KHC)
Occidental Petroleum (OXY)

Buffett also has several large stakes in privately held companies, such as Burlington Northern Santa Fe (BNSF) Railroad and GEICO Insurance.

What Companies Does Warren Buffett Own?

Warren Buffett has a stake in many companies through his holding company, Berkshire Hathaway. Some of his largest holdings include Bank of America, Apple, American Express, and Coca-Cola.

How Did Warren Buffett Become Rich?

Warren Buffett became rich steadily over a long period of time, primarily through investing which he began doing at the age of 11. He started his own business venture as a paperboy at 13 and he also sold horse racing tip sheets. He formed his own company as an adult and began investing in companies he believed were undervalued, earning profits. He reinvested those profits in more investments and his wealth continued to grow.

He eventually bought Berkshire Hathaway, where he continued with his value investing strategy.

Is Warren Buffett Self-Made?

Warren Buffett is self-made although he did come from a fairly privileged background. His father owned a stock brokerage firm and eventually became a U.S. Congressman. This allowed Buffett to attend prestigious schools, such as Columbia University. But he did start his own company and make his own investments, which eventually led to his enormous wealth.

What Is the Best Investment According to Warren Buffett?

According to Warren Buffet, “The best investment—by far—is developing yourself.” In particular, he says, “I would say communications skills are the first area I would work on to enhance your value throughout life...if you can’t talk to people, you’ve got a real problem selling securities.”

You must ultimately develop skills that other people are willing to pay for. You’re set for success when you do, Buffett says, or, as he puts it in financially-tinged language, “Your abilities can’t be inflated away from you.”

The Bottom Line

Buffett’s investing style is like the shopping style of a bargain hunter. It reflects a practical, down-to-earth attitude. Buffett maintains this attitude in other areas of his life. He doesn’t live in a huge house, he doesn’t collect cars, and he doesn’t take a limousine to work. The value-investing style is not without its critics but the proof is in the pudding regardless of whether you admire Buffett or you don't.