There isn’t an investor in the world who hasn’t heard of Warren Buffet. He’s an investing legend and one of the richest people in the world. His estimated net worth sits at approximately 102 billion as of October 2021, according to Forbes.
He is not only one of the most successful investors in the world, he’s also one of the biggest philanthropists. It’s estimated that Warren Buffett has given away more than $41 billion to charities worldwide and that number continues to climb every year.
He is best known for following in the footsteps of Benjamin Graham, who is widely known as the father of value investing. Graham played a major role in shaping Buffett’s investment style and philosophy. Throughout his illustrious career, Buffett has closely followed important rules in investing which has led to his success. In this article, we will explore Warren Buffett’s investment style, how it works, and how he used to grow his wealth year after year.
- Warren Buffett’s investment style is highly influenced by Benjamin Graham.
- His investment style focuses on finding undervalued companies based on their intrinsic value.
- Some of the factors that Warren Buffett considers are company debt, profit margins, and return on equity.
- Buffett likes to take his time and access the company as a whole and doesn’t let short term price behavior influence his investing philosophy.
Brief History of Warren Buffett
Warren Buffett, also commonly referred to as the “Oracle of Omaha”, was born on August 30, 1930, in Omaha Nebraska.
He developed an interest in business and investing at an early age and started his education at the Wharton School at the University of Pennsylvania. He later went to the Columbia Business School where he received his graduate degree in economics and began to mold his investment style and philosophy after the teachings of Benjamin Graham.
Buffett would go on to work as an investment salesman from 1951-1954 where he honed his sales and investment skills. He later formed Buffett Partnership, LTD in 1956, and his firm went on to acquire textile manufacturing firm, Berkshire Hathaway.
From 1970 he has served as the chairman and CEO of Berkshire Hathaway and has grown it to one of the most successful investment firms. Charlie Munger, his long-time friend, and partner joined the firm in 1978 as vice-president.
Warren Buffett’s Investing Style
Warren Buffett’s investing philosophy and style is unlike any other investor on the planet. It’s old school, boring, but extremely successful. His investing style leans heavily on the teachings of Benjamin Graham and his value investing philosophy.
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Value investors focus on finding companies with prices that are much lower than their intrinsic or book value. This requires investors to look for companies with strong underlying fundamentals which can often times be overlooked by the rest of Wall Street.
Much like someone looking for a good deal, Buffett looks for companies that are undervalued by the rest of the market that will perform well in the long term.
When asked by a reporter what his favorite holding period for stocks is Buffett replied, “my favorite holding period is forever”. This goes hand in hand with the philosophy that was instilled in him through the teachings of Benjamin Graham. Buffett really isn’t concerned with the short-term fluctuations in the price of the stock. He’s more interested in how the stock will behave 5, 10, and even 15 years from now.
One of the key quantitative metrics that Buffett looks at is company debt. Specifically, he focuses on the debt-to-equity ratio (D/E) of the company. He focuses on finding companies with low to moderate levels of debt that generate their earnings growth primarily from their shareholders’ equity rather than debt.
The debt-to-equity ratio calculation
D/E = Total Liabilities ÷ Shareholders’ Equity
The D/E ratio shows the proportion of equity and debt used by the company to finance its assets. The higher the ratio, the more debt that the company uses to finance its operations. The lower the ratio, the lower the amount of debt being used to generate earnings growth.
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Warren Buffett focuses on finding companies that don’t have massive debt and rely upon no positive cash flow to finance their operations and growth.
Another quantitative factor that Warren Buffett focuses on when buying stock in a company is a stable and growing profit margin. He finds it important to find a company that has a solid track record of stable profit margins over the course of at least 5 years.
Profit Margin Calculation
Profit margin = Net income ÷ Net Sales
A high-profit margin shows that a company is controlling its costs and running its business efficiently. It’s worth noting that profit margins will vary widely based on the sector the company is in.
Return on Equity (ROE)
Another important factor that Warren Buffett takes into consideration is the return-on-equity. The ROE is an important component to consider in value investing. It reveals the rate at which shareholders earn income on their shares.
Warren Buffett has used ROE as a comparative metric to see whether or not a company has performed well against it’s competitors.
ROE = Net Income ÷ Shareholder’s Equity
An often overlooked qualitative factor in investing is the strength of the company’s management. Warren Buffett takes a careful look at a companies structure and management. Some of the management factors he looks at include:
- The experience level of management
- The tenure of the management team
- The size of their management team
- Integrity and talent of managers
- The leadership of the management team
These are important factors to consider if you plan on investing in a company for a long period of time. They are often overlooked by seasoned investors, who tend to strictly focus on quantitative investing factors.
Reliance on Commodities
Some investors might overlook how reliant a company is on commodity resources. Warren Buffett believes it’s important to analyze the degree to which a company relies on it’s commodities such as oil, gas, metals, or energy.
He believes it’s important that company has product and services that have a competitive edge and simply different than that of it’s competitors. A company should have a strong brand that can be invested in for the long term. He believes that a company with products and services that are hard to replicate holds a competitive advantage in the marketplace.
Examples include: Apple, Coca-Cola, Nike
Warren Buffett prefers to invest in companies that have a proven track record of success and that have been around for a minimum of 10 years. This gives him the necessary confidence in the company’s products, management, and financial performance.
A company’s historical performance speaks volumes as to how a company navigates changes, competition, technological advancement, and management change. The goal of value investors is to determine how well the company can perform in the future by analyzing it’s past.
Is The Stock Trading Below Intrinsic Value
The intrinsic value is perhaps one of the most important factors to consider for value investors. If you want to become a true value investor you have to focus on finding companies that are undervalued.
The intrinsic value of a company consists of many different factors. They include:
Finding out the intrinsic value can be a complicated endeavor. One of the most popular ways to determine a company’s intrinsic value is through the discounted cash flow (DCF) model. It uses the company’s free cash flow and the weighted average cost of capital to help determine an accurate intrinsic value.
Once the intrinsic value is determined, then it is compared to the current market cap. This to get an accurate estimate whether or not the company is undervalued.
As you can see, Warren Buffett’s investment style focuses on finding a great deal through many different fundamental factors and it has been the beacon to his success. Not only does he maintain this philosophy in his investing, but he is also known for being and extremely frugal and generous person.