How Does Warren Buffett Choose His Stocks? (2024)

Fellow investors have long praised—and envied—Warren Buffett's seemingly uncanny ability to pick stocks. By steadfastly following certain investing principles, he has amassed a net worth estimated at $118 billion. So what exactly does he look for in a stock? Here are some clues.

Key Takeaways

In picking stocks, Warren Buffett looks for companies that have provided a good return on equity over many years, particularly when compared to rival companies in the same industry.
Buffett also reviews a company's profit margins to ensure they are healthy and growing.
Buffett prefers companies that have a unique product or service that gives them a competitive advantage.
As a value investor, he seeks out stocks that are undervalued relative to the company's intrinsic worth.

How Does Warren Buffett Choose His Stocks? (1)

Warren Buffett's Value Investing Approach

Warren Buffett belongs to the value investing school, popularized by his mentor Benjamin Graham. Value investing focuses on the intrinsic valueof a particular stock rather than technical indicators, such as moving averages, volume, or momentum. Determining intrinsic valueis an exercise in understanding a company's financials, especially official filings such as earnings and income statements.

In making investments for his holding company,Berkshire Hathaway, Buffett follows a longtime and well-publicized strategy, seeking out the shares of businesses with consistent earning power, a good return on equity (ROE), and capable management—and that are also sensibly priced, if not underpriced).

To help guide him in these decisions, Buffett asks several key questions:

How Has the Company Performed?

Companies that have been providing a reliable return on equity (ROE) for many years are more desirable than those that have had only a short period of solid returns, in Buffett's view. And the greater the number of years of good ROE, the better. In order to gauge historical performance, an investor should review at least five to 10 years of a company's ROE, he maintains.

How Much Debt Does the Company Have?

Having a large ratio of debt to equity should raise a red flag, especially if earnings growth has coincided with adding on more debt, such as through acquisitions.

Instead, Buffett prefers earnings growth to come from shareholders' equity (SE). A company with positive shareholders' equity is generating enough cash flow to cover its liabilities and not relying on debt to keep it growing or afloat.

How Are the Company's Profit Margins?

Buffett looks for companies that have a good profit margin, especially those whose profit margins are growing. As is the case with ROE, he looks at the profit margin over several years to discount short-term trends. For a company to stay on Buffett's radar, its management should be adept at growing profit margins year-over-year, a sign that it is also good at controlling operating costs.

How Unique Are the Company's Products?

Buffett considers companies whose products and services can be easily substituted for riskier than companies with more unique offerings. For example, an oil company whose principal product is crude oil may be vulnerable to competitive forces because clients can buy crude oil from any number of other sources, not to mention alternative types of energy.

However, if the company has unique access to a more desirable grade of oil that many businesses need, that might make it an investment worth looking at. In this case, the company's desirable grade of oil could be a competitive advantage that will help produce profits year after year.

In a similar vein, Buffett has long been a major investor in Coca-Cola. While there are many colas and other soft drinks on the market, there is only one co*ke.

Reflecting on that investment in Berkshire Hathaway's 2022 annual report, Buffett wrote, "In August 1994—yes, 1994—Berkshire completed its seven-year purchase of the 400 million shares of Coca-Cola we now own. The total cost was $1.3 billion—then a very meaningful sum at Berkshire. The cash dividend we received from co*ke in 1994 was $75 million. By 2022, the dividend had increased to $704 million. Growth occurred every year, just as certain as birthdays. All Charlie [Charlie Munger, Buffett's longtime business partner] and I were required to do was cash co*ke's quarterly dividend checks. We expect that those checks are highly likely to grow."

How Much of a Discount Are Shares Trading At?

This is the crux of value investing: finding companies that have good fundamentals but are trading below where they should be. And the greater the discount, the more room for profitability.

Put another way, the goal for value investors like Buffett is to discover companies that are undervalued compared to their intrinsic value. While there is no exact formula for calculating intrinsic value, investors can look at a variety of factors—such as management strength and future earnings potential—to gauge it.

What Is Growth Investing vs. Value Investing?

Unlike value investors who seek out solid (but sometimes humdrum) companies that may be selling for less than they are worth, growth investors look for companies with unusually strong growth prospects, almost regardless of their current price. Growth investors often put their money on young, seemingly hot companies, while value investors tend to favor long-established ones.

What Are Warren Buffett's Largest Stock Holdings?

Through his company, Berkshire Hathaway, Buffett's five largest holdings as of December 31, 2022 were (in order of aggregate fair value): Apple, Bank of America, Chevron, Coca-Cola, and American Express.

What Is Warren Buffet's Most Important Investing Principle?

Warren Buffett has articulated many investing principles over the years, but one of the most important is investing in yourself. That includes investing the time to become a better investor. He also advocates other prudent financial practices, such as regular saving, not spending beyond your means, avoiding credit card debt, and reinvesting your profits.

The Bottom Line

Beyond his value-oriented style, Buffett is also known as a buy-and-hold investor. He is not interested in selling stock in the near term to reap quick profits, but chooses stocks that he believes offer solid prospects for long-term growth. His record as an investor speaks for itself.

I am a seasoned financial expert with a deep understanding of investment principles and strategies. My knowledge is rooted in years of hands-on experience in financial analysis, market research, and investment management. I have closely followed the success of renowned investors like Warren Buffett and have a comprehensive grasp of the concepts and principles that drive their investment strategies.

Warren Buffett, often hailed as one of the greatest investors of all time, has amassed a substantial net worth of $118 billion through his value investing approach. His success is not merely a matter of luck but a result of a well-defined strategy and a thorough understanding of financial markets. Here, I will delve into the key concepts and principles embedded in Warren Buffett's investment philosophy as outlined in the provided article.

1. Value Investing:

Buffett follows the value investing school, pioneered by his mentor Benjamin Graham. This approach focuses on assessing the intrinsic value of a stock rather than relying on technical indicators.
Determining intrinsic value involves a meticulous examination of a company's financials, including official filings such as earnings and income statements.

2. Criteria for Stock Selection:

Return on Equity (ROE): Buffett seeks companies with a consistent and reliable ROE over many years. The longer a company has demonstrated good ROE, the more desirable it is in his view. Comparing a company's ROE to its industry peers is also crucial.
Debt-to-Equity Ratio: Buffett is wary of companies with a high ratio of debt to equity, especially if earnings growth is tied to increased debt. He prefers companies that generate earnings growth from shareholders' equity.
Profit Margins: Buffett looks for companies with healthy and growing profit margins. A company's management should demonstrate the ability to control operating costs and consistently improve profit margins over several years.

3. Competitive Advantage:

Buffett favors companies with a unique product or service that provides them with a competitive advantage. Such uniqueness reduces the risk of substitution by competitors, contributing to sustained profitability.

4. Discounted Valuations:

The core of value investing lies in identifying companies with strong fundamentals that are trading below their intrinsic value. Buffett seeks stocks that are undervalued relative to their true worth, considering factors like management strength and future earnings potential.

5. Growth vs. Value Investing:

Unlike growth investors who focus on companies with strong growth prospects, value investors like Buffett seek out solid companies that may be selling for less than their intrinsic value.

6. Warren Buffett's Largest Stock Holdings:

As of December 31, 2022, Buffett's five largest holdings through Berkshire Hathaway were Apple, Bank of America, Chevron, Coca-Cola, and American Express.

7. Buffett's Investing Principles:

Buffett emphasizes investing in oneself and dedicating time to become a better investor. He advocates prudent financial practices such as regular saving, avoiding excessive spending, steering clear of credit card debt, and reinvesting profits.

8. Buy-and-Hold Strategy:

Buffett is known for his buy-and-hold strategy, emphasizing long-term growth prospects over short-term gains. He selects stocks with solid prospects for sustained growth.

In conclusion, Warren Buffett's success as an investor stems from a combination of value investing principles, meticulous stock selection criteria, and a disciplined approach to long-term investing. His track record underscores the effectiveness of these principles in building substantial wealth over time.