How Warren Buffett Invests in Companies: Three Things He Never Misses

Warren Buffett is a renowned American investor. He is also the chairman and CEO of Berkshire Hathaway, which has the world’s most expensive share. Mr. Buffett is known worldwide for his “value investing” approach where he invests in companies with strong fundamentals. As a smart investor, he specifically looks for a strong and sustainable competitive advantage that he often referred to as an "economic moat."

In this article, let’s understand in detail how Warren Buffett invests in companies and learn the three key factors he always evaluates.

• While investing, Buffett focuses on intrinsic value. This helps him find undervalued stocks.
• Competitive advantage, or a "moat," is essential for a company’s long-term success.
• The "buy and hold" strategy helps build long-term wealth by ignoring short-term market fluctuations.

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.

Warren Buffett stresses that investors should only invest in businesses they fully understand. This idea is called the "circle of competence." It means you must focus on industries or companies where you have knowledge or expertise. By sticking to what you know, you can make informed decisions and assess risks more accurately.

To make this happen practically, Buffett advises thoroughly studying the industry and its market position. Also, special research should be done to check the company’s management quality. By following this approach, investors can avoid mistakes and increase their chances of long-term success.