How does Warren Buffett beat the stock market?

Warren Buffett is the world’s greatest investor as he’s renowned for being able to beat the stock market. Here’s how he does it.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Fans of Warren Buffett taking his photo

Image source: The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Key Points

  • Warren Buffett is the greatest investor in the world as he's known for outperforming the stock market.
  • Berkshire Hathaway has outperformed the S&P 500 this year due to excellent decision-making.
  • Following Buffett's investing philosophy could generate my portfolio excellent returns as well.

Beating the stock market on a consistent basis, over a long period is a difficult task. Maybe almost impossible. However, Warren Buffett and his partner Charlie Munger are among very few investors who have ever achieved such a feat. His fund, Berkshire Hathaway (NYSE: BRK.A) has outperformed the S&P 500 by almost 3,000% since its inception! So, here’s how he does it.

Quality is invaluable

It’s no secret that Warren Buffett only invests in quality stocks that provide good value. Over his decades of investing, he’s reiterated that a good investment has three main factors:

  1. A good valuation with room for growth.
  2. Strong pricing power and fundamentals.
  3. An excellent moat with a margin of safety.

This is evident when analysing his company’s portfolio. The firm has positions in many of the world’s biggest companies. Many of these stocks have one thing in common. They’re market leaders that exhibit quality profit margins and healthy fundamentals.

Top 5 Companies Held by Berkshire Hathaway (Q4 2021)Percentage of Portfolio
Apple42.8%
Bank of America14.6%
American Express8.7%
Coca-Cola7.1%
Kraft Heinz4.1%
Source: Warren Buffett 2022 Portfolio

A buffet of stocks

As the US S&P 500 flirts with bear market territory, the Oracle of Omaha has been going on a shopping spree. Warren Buffett has been buying shares in excellent companies for cheap valuations, having done the same during the 2008 financial crisis. He’s made mistakes in his investing career too, but he learns from them and moves on.

Be fearful when others are greedy, and greedy when others are fearful.

Warren Buffett

The current forward price-to-earnings (P/E) multiple for the S&P 500 stands at 16.6. This is below the five-year average of 18.6, and 10-year average of 16.9. As such, Warren Buffett has increased and even bought positions in several blue-chip stocks. These include PC giant HP, oil behemoths Chevron and Occidental Petroleum, and recently, entertainment conglomerate Paramount Global.

These purchases allow Warren Buffett to dollar cost average, as he continues to buy value stocks on the dip. Berkshire’s move to increase its stake in oil also allowed the firm to capitalise on sky-high oil prices. This has allowed the fund to hedge against the potential slowdown in earnings from its other positions. Consequently, Berkshire Hathaway has outperformed the S&P 500 by almost 20% this year.

Keeping it simple

Warren Buffett has always stressed on keeping investing simple. Buy shares in a great business for less than it’s worth, with managers of the highest integrity and ability. But what is a great business? As hinted at earlier, these are businesses with low debt, high levels of cash, healthy margins, strong growth, and an inelastic good/service. While this may seem simple, companies exhibiting all these traits are difficult to find.

So, despite already having an array of renowned names on his portfolio, the 91-year-old has expressed his regret in not purchasing shares of several top US companies. One is a personal favourite of mine, Alphabet. Although the tech giant came short of earnings expectations recently, he sees plenty of promise in the Google-owning firm. With a 20-1 stock split around the corner, I think Berkshire may add Alphabet to its portfolio. If so, I’d be even more confident in Warren Buffett’s ability to continue beating the stock market.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

John Choong owns shares of Alphabet (Class A Shares) at the time of writing. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. American Express is an advertising partner of The Ascent, a Motley Fool company. The Motley Fool UK has recommended Alphabet (A shares), Alphabet (C shares), and Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Middle-aged Caucasian woman deep in thought while looking out of the window
Investing Articles

If I’d invested £1,000 in Lloyds shares at the start of the year, here’s what I’d have now

The stock market is unmoved, but Stephen Wright thinks last year’s record profits might give Lloyds shares a long-term boost.

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

I’ll snap up shares in this growth stock in March if others don’t get there first

This Fool says shares in this growth stock are stable, full of profit, and might be undervalued. But there are…

Read more »

Rainbow foil balloon of the number two on pink background
Investing Articles

My 2 top energy investment trust picks for a passive income

I'm aiming to buy more of these investment trusts for a passive income and the reasonably stable energy sector returns…

Read more »

Storytelling image of a multiethnic senior couple in love - Elderly married couple dating outdoors, love emotions and feelings
Investing Articles

5.5% dividend yield! Shares like these could be great for my retirement

Oliver Rodzianko thinks this company with a stellar dividend yield could be very useful when looking for income from his…

Read more »

Investing Articles

Should I buy this FTSE 250 stock as it soars back to the FTSE 100?

This FTSE 250 stock has rallied following its pandemic woes. This Fool thinks now could be a good time to…

Read more »

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

How I’d aim to transform an empty Stocks & Shares ISA into £1m of wealth!

There's never a better time to start investing in a Stocks and Shares ISA than today. Here's how I'd aim…

Read more »

Close up of manual worker's equipment at construction site without people.
Investing Articles

Investing £14,708 in this FTSE 100 stock could earn me £1,000 per year in passive income

Is a CMA investigation into anticompetitive practices the cloud cover Stephen Wright needs to start buying shares in a FTSE…

Read more »

Investing Articles

Despite rising 152% in a year, is Rolls-Royce’s share price still a bargain?

While Rolls-Royce’s share price has shot up recently, it still looks very undervalued against its peers, and the business looks…

Read more »