Warren Buffett has a knack for finding high-return equity investments. Between 1965 and 2020, the holding company Buffett runs, Berkshire Hathaway, delivered a compound annual gain of 20%. That’s nearly double the S&P 500‘s annual growth of 10.2% in the same timeframe.
Fortunately for the investment community, Buffett likes to share his methods with the masses. In early 2008, he outlined four traits he and his fellow Berkshire leader Charlie Munger use to identify investable companies:
Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag.
Below is a closer look at those four traits and how you can apply them to your own investing.
1. A business we understand
Buffett has long expressed the importance of investing within your circle of competence. Investing in a company you understand has these advantages:
- You have a better sense of that company’s strengths and weaknesses.
- You can make better, faster decisions and judgments when you receive new information.
- You are more connected to the investment. Your position is more than something you hope will be profitable; it’s a business you enjoy following.
2. Favorable long-term economics
Favorable long-term economics boil down to strong returns on invested capital today, plus a hefty competitive advantage to protect those returns over time. The advantage could be the industry’s most efficient cost structure or a brand that’s beloved by consumers around the world.
Whatever the advantage, it must be lasting. A competitive advantage that’s easily copied or dismantled fails the long-term test.
This is one reason Buffett prefers stable industries over industries in flux. Change, whether in regulations, demand, or technology, can weaken competitive advantages in ways that are hard to predict.
3. Able and trustworthy management
In the absence of scandal, it’s hard for individual investors to…
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