Learning how to pick stocks as successfully as legendary investors like Warren Buffett is not easy. But over the years, the ‘Oracle of Omaha’ has given out a lot of advice in his annual shareholder letters about his stock-picking strategy. And while there are some intricacies, the core of his approach is actually pretty straightforward.
With that in mind, let’s take a look at some of the key points Buffett looks for when picking stocks.
#1 Pick wonderful businesses with competitive advantages
Something that can be often forgotten is that shares represent a piece of a business. And over the long term, if that business does well, the stock will follow. This is why Buffett focuses on the underlying company rather than the ticker symbol. And given that he’s now a stock market billionaire, I think it’s fair to say this approach is the right way to go.
So, what makes a business “wonderful”? While no two companies are completely alike, there is a recurring theme among some of today’s most successful enterprises. They all have competitive advantages.
This could be something as simple as having a well-known brand that enables the group to charge higher prices, to something more complex, like access to a unique mineral deposit. These advantages can provide a substantial buffer against competing forces seeking to steal market share. And consequently, with rivals unable to dethrone a rising firm, it can continue to deliver explosive performances for shareholders.
This is one of the core principles of how Buffett picks stocks.
#2 Avoiding too much debt
When used correctly, debt can be a powerful tool to fuel growth. But all to often companies can quickly find themselves in trouble with the balance sheet becoming compromised and profit margins getting squeezed due to interest payments.
That’s why the term “cash is king” is often thrown around in the investment community. And it’s something Buffett likes to place particular emphasis on when picking stocks.
Businesses capable of generating substantial cash flow aren’t likely to struggle to keep up with operating expenses or loan interest obligations. As such, they are far less prone to insolvency. And simultaneously, they aren’t as dependent on external financing to fund long-term research & development, acquisitions, or general opportunities in the pursuit of creating value for shareholders.
Final thoughts on Buffett’s stock-picking strategies
These two key traits are by no means a complete checklist of what makes a good stock pick. But in my experience, it can quickly differentiate the wonderful from the mediocre. Of course, there is no guarantee that a low-debt company with many competitive advantages will result in a lucrative investment. After all, there are always disruptive forces at play.
But, in my opinion, by using Buffett’s stock-picking strategy, the odds of finding winning investments significant improve.
