To many, Warren Buffett is one of the greatest investors of all time. His seemingly boring buy-and-hold value investing strategy has proven immensely successful, turning a mere $100 at the age of 11 into over $110bn in 2022.
Needless to say, investors capable of replicating his performance could find themselves sitting on a fortune, enough even to retire early. Obviously, this is far easier said than done. And there have been plenty of failed attempts to replicate his investing journey.
Nevertheless, those executing Buffett’s investing method could still amass a respectable nest egg, even if their performance doesn’t quite reach the Oracle of Omaha’s 20% average annual return. So the next question is, how does Buffett pick stocks?
Focus on terrific businesses at fair prices
In the short term, the stock market is moved by investor sentiment. But in the long run, share prices are driven by the value of the underlying business. If revenue, earnings, and cash flow are all heading in the right direction, the company becomes more valuable, driving up the market capitalisation and, in turn, the stock price.
The challenge is spotting which companies can deliver consistent growth and value for years and even decades to come. And that’s Buffett’s speciality.
Financial statement analysis has an important role to play in stock picking. But a thriving business today may not stay that way if it doesn’t have any critical competitive advantages.
Advantages can come in many forms. And a few examples include:
- Branding: customers will be willing to pay more for goods and services from a reputable brand known for quality
- Switching Costs: a product or service so heavily integrated into a customer’s business pipeline that it becomes uneconomical to switch to a competitor, even if they’re cheaper
- Unique Operating Model: a method of working that is more efficient than competitors, resulting in higher profit margins
However, even the world’s greatest business can still be a poor investment if the wrong price is paid. Over-excited investors can quickly drive a stock price far beyond its fair value. And it doesn’t take much for this house of cards to tumble. Even Buffett has fallen into the trap of overpaying throughout his investing career, with his most recent blunder being Kraft Heinz.
Building wealth like Buffett
Historically, the FTSE 100 has delivered an average return of around 7%, including dividends. But by deploying Buffett’s investing style, an investor could boost those returns significantly, providing they are successful in picking winning stocks.
Buying individual stocks with £500 a month is undoubtedly riskier than just slapping the money into an index fund. But suppose an investor manages to boost their average returns to just 10%? In that case, over 25 years, it can mean the difference between an investment portfolio worth £405,000 and £663,400. And if an investor can defy all odds and match Buffett’s historical performance, the same portfolio would be worth £4,242,600.
The point is even an investor in their early 40s has enough time to amass a larger nest egg. And while stock market crashes and corrections occasionally throw a spanner into the works, careful financial planning can help mitigate these frustrating storms.