Warren Buffett does not readily disclose the investments he makes on behalf of himself or Berkshire Hathaway. He does, every year, report on the substantial holdings of his company in other corporations. These provide only tiny clues however to why, when and where he invests.
He is prepared, however, and does so regularly, to outline general principles of sound investment. These have a consistent theme and can be summed up like this.
Stock investments should be looked at in the same way as buying a business. The stock investor is really buying a tiny share or partnership and should apply the same principles that they would in buying a business – the Benjamin Graham approach:
1. The company should be soundly managed. Tests of good management include:
2. The company has demonstrated earning capacity with a likelihood that this will continue. Tests of earning capacity include:
- Company growth
- Dealing with inflation
- Capital expenditure
- Look through earnings
- Brand names
3. The company should have consistently high returns. Warren Buffett would look at both:
4. The company should have a prudent approach to debt.
5. The businesses of the company should be simple and the investor should have an understanding of the company.
See case studies.
6. Assuming that all these thresholds are satisfied, the investment should only be made at a reasonable price, with a margin of safety. This is always a matter for independent judgment by the investor but it is relevant to consider:
- Price/earnings ratios
- Earnings and Dividend yields
- Book value, particularly where there is a high proportion of economic good will
- Comparative rates of return
7. You need to be patient and wait for the opportunity to buy at the price that you have decided gives you the appropriate margin of safety. The vagaries of the market, encapsulated in Benjamin Graham’s famous instructive character, Mr Market, will provide buying opportunities.
8. Investors need to take a long term approach.
Buffett has made it quite clear that the investment decision is a wholistic one, taking into account all factors, and that no one factor is the determining one.
