Warren Buffett is widely considered to be one of the greatest investors that’s ever lived and we can learn a lot from his style of investing.
You don’t need to hold any high-level financial qualifications to follow his methods, Buffett loves simplicity and generally looks for 12 investing tenets, or key considerations, when evaluating an investment.
The business
Buffett’s first test is to make sure that he understands the business. For example, Diageo (LSE: DGE) (NYSE:DEO.US) is the world’s largest alcoholic beverage producer and distributor, the company makes and sells booze, mainly vodka and whiskey. That’s not hard to understand.
Reckitt Benckiser (LSE: RB) manufactures, among other things, condoms and washing powder. Unilever(LSE: ULVR) (NYSE: UL.US) also keeps things simple — the company produces and sells a number of household cleaning products and popular food brands. Again, they’re pretty straightforward businesses.
The second step in Buffett’s analysis is to check out the historic performance of his prospective investments. For Reckitt, Unilever and Diageo this is a simple task. Diageo for example, owns a number of key brands, such as Guinness and Smirnoff Vodka which have been around for decades and continue to prove popular with customers. Additionally, Reckitt has been around since 1823, having started from a small starch-mill in Hull.
When Buffett has checked the history of his prospective investments, he checks out the future prospects. In other words, will the company still be around a 100 years from now, will the company still be relevant?
This question is tough to answer, but the defensive qualities of Reckitt, Unilever and Diageo all imply that the companies are here to stay. Indeed, their products have become staples of everyday life, something that’s not likely to change soon.
Management
After Buffett has studied the business and its prospects, he concentrates on the quality of the company in questions management.
Now, it’s hard to describe how he analyses this aspect, but essentially he looks for two things. Firstly, has management returned cash to investors? And secondly, has management materially increased shareholder value?
The management teams of Unilever, Diageo and Reckitt have all worked hard to increase shareholder value over the past decade. Excluding dividends, Unilever’s share price has risen 149% since August 2004, Reckitt’s share price has jumped 271% over the same period and Diageo’s has gained 154%. All companies have outperformed the FTSE 100, which only returned 54% over the period.
Over the past five years, Unilever has increased its dividend payout to investors by a compounded 260%, Reckitt’s payout has increased by 38% and Diageo’s payout has risen 45%.
Financial measures and value
A
fter getting to grips with the business and its management Buffett starts to crunch the numbers. There are many methods the oracle of Omaha uses to compute the figures and arrive at a suitable conclusion and it’s important to remember that Buffett is more willing to “buy a wonderful company at a fair price than a fair company at a wonderful price.”
Unilever, Reckitt and Diageo are hardly cheap as they trade at forward P/E’s of 20, 19.8 and 17 respectively, above the FTSE 100 average of 13.3. But they are all quality businesses, which have a record of creating shareholder value.
At present, Unilever supports a dividend yield of 3.5%, Reckitt supports a yield of 2.6% and Diageo a yield of 3%, so buy-and-hold investors will be paid to wait.
