When it comes to evaluating investments, Mr. Buffett always follows a disciplined approach. In particular, he prioritises three key factors:
- The company's intrinsic value
- Its competitive advantage
- Whether the stock is apt for long-term investment
These factors guide him in making value-driven investment decisions. Let’s study them in detail:
1. Determine the intrinsic value of the company
Warren Buffett always focuses on the intrinsic value of a company. For those unaware, it represents the “true worth” which is calculated using fundamental factors and not just market trends or current performance. He believes that the market often misprices stocks. Therefore, investors must keep patience and try to identify undervalued stocks. By doing so, they will benefit in the long run when the market realises the true value of these undervalued stocks.
To determine a company's intrinsic value. Mr. Buffett prefers using “Return on Equity (ROE)”. It is a metric that shows how well a company uses shareholders' money to generate profit. A consistently high ROE over 5-10 years indicates a strong company. Next, he also used “The Debt to Equity Ratio”, where lower debt suggests that the company generates earnings from equity rather than borrowing. In his entire investment career, Buffett always preferred companies with low debt.
Moreover, Buffett always encouraged investors to “avoid emotional investing”. Instead of getting influenced by market hype or fear, investors should make decisions based on rational analysis. Ideally, investors should not follow the crowd but find strong stocks that are overlooked.
2. Look for competitive advantage
In Warren Buffett’s opinion, companies with a sustainable competitive advantage perform better in the long run. These companies have something special that makes them stand out from their competitors. This could be anything from a well-known brand, loyal customers, or the ability to control pricing. Also, these companies offer unique products or services that are hard to replicate. Because of these advantages, they capture more market share and build strong customer loyalty.
Such companies were described by Mr. Buffett as one with a "moat". The moat represents the company's competitive edge or features that are hard for competitors to imitate or surpass. As a thumb rule devised by him, the wider the moat, the harder it is for rivals to steal market share. Therefore, companies with a strong moat can defeat competition and even keep customers coming back.
3. Can you buy and hold the stock
Warren Buffett is a strong believer in the "buy and hold" strategy. Following this technique, investors purchase stocks and hold them for a long time. They do not pay heed to short-term fluctuations. This approach helps investors create long-term wealth. Next, in support of his ideology, Buffett also argues that it is easier to predict a company's future success over 10-20 years than in the short term.
Buffett’s investment in “Wrigley’s chewing gum” clearly shows this strategy. He knew that no matter how advanced technology gets, people’s preference for chewing gum wouldn’t change. This confidence in Wrigley’s long-term success led him to hold the stock for many years. When he eventually sold it, his initial investment of USD 2.1 billion grew to USD 23 billion.
