Warren Buffett has been hailed as an investing role-model for decades. But his investment strategy hasn’t stayed the same over time. Let me explain how his strategy has evolved over the years.
Warren Buffett started out as Benjamin Graham’s most capable student and business partner. Graham, the father of value investing, loved hunting for bargains. Apart from the low price-to-earnings, low price-to-book, and increasing profitability and dividends, Graham used the net current value formula to find bargain companies. This means finding companies with market capitalisation significantly below the value of their net current assets.
As can be seen, Graham’s approach towards investing was highly quantitative. He paid plenty of attention to accounting fundamentals, but did not consider his potential targets’ growth potential. For example, qualitative analysis of an enterprise would include assessing the opportunities and threats the industry and the company are facing. It would also include assessing the firm’s popularity among consumers as well as its key competitors.
At first, Buffett identified potential bargains using Graham’s accounting approach. However, his method of finding firms to invest in changed.
Buffett formed his own firm and then met Charlie Munger, who became his second-in-command at Berkshire Hathaway. Munger and Buffett’s current method of choosing companies could be best summarised as “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
This simply means that Buffett still attempts to find companies selling below their intrinsic or fair value. Yet, he would rather a great company than a mediocre one, a distinction that involves some qualitative analysis.
This can be illustrated by his purchase of Amazon shares last year. Amazon, a company that has never paid dividends, trades at a price-to-earnings ratio of over 80, which is really high. Yet, Buffett still bought it for its great growth potential.
He still pays very close attention to current accounting fundamentals but also tries to predict the future earnings of an enterprise he is about to acquire.
Needless to say, his favourite holding period is forever.
Warren Buffett and Phillip Fisher
Buffett’s investment strategy change was not only due to his business partner Munger. The Oracle of Omaha is also an admirer of Philip Fisher, who advised investors to find answers to the following qualitative questions:
- Does the company have a diversified product range and sufficient market growth potential?
- Is the company’s management willing to develop new products if the demand for old products falls?
- How about the firm’s competitors? Are they more financially sound? Do they produce more popular products?
- Does the industry itself have a future?
- How effectively does the company invest in research and development?
- Does the company enjoy high repeat sales and satisfied customers?
- How about the corporate culture and employee satisfaction?
- Can the company survive on its own without relying on one brilliant manager?
- Does the company’s management aim to achieve short-term or long-term profits?
- Does the management have a perfect reputation?
- Is the management fully open with its shareholders? Does the CEO try to oversell the company’s success during hard times?
Choosing individual shares can be a tough task but following in Buffett’s lead is a good way to start. Now could be golden days for an individual investor to buy excellent companies at a discount.
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Views expressed 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.