How does Warren Buffett find great investments?

Over the years, Warren Buffett through his letters to shareholders, interviews and articles has shared extensively on what to look out for before deciding to make an investment. I recently came across a book titled ‘Inside The investments of Warren Buffett’ by Yefei Lu which gives a detailed insight into Buffett’s 20 biggest investments. What readers can find is that there is an overarching theme across each of these investments, and a process-driven approach to justifying what is a viable opportunity. While one can assemble a laundry list of investment advice from Buffett, the points included in this article are found consistently across each of his investments.

Quality Information Matters

For Buffett, having quality information and conducting thorough research meant everything. While it is certainly true that Buffett was diligent in learning about all aspects of a business, he focused especially on investment cases that are backed by concrete and objective data points. Having a wide array of information on a business and understanding what these data points meant for its future prospects allowed him to confidently stay concentrated rather than diversify his investments. What made his approach a lot different from other investors is that this information did not solely rely on annual reports but also on industry-wide data. This gave him a measure of not only how an individual company performed on a month-to-month and year-to-year basis, but also how it compared to others. As a whole, it is also evident that the industries Buffett revisits - media, insurance and branded products, were ones with ample objective industry information. Having great objective information allowed buffet to make the big bets that defined his concentrated approach to investing. Without high-quality information to support your qualitative insight, the best path investor should take is probably not to invest.

Consistency of Earnings Growth

Over the years, Buffet has been associated with making investments in ‘high-quality’ businesses with an enduring brand name such as Coca-Cola or American Express. These businesses are also described as being compounders with high returns of capital and durable competitive advantages(Moats). For Buffet, factors such as network effects, switching costs, and scale benefits were secondary when making a dependable prediction on the future prospects of a company. Much of the investments Buffet made were in companies that had extremely consistent revenue and earnings growth in the years preceding the investment. In most cases, many of his investments had grown revenues or earnings in nine out of the previous 10 years. Buffet clearly viewed consistent historical financials and good data as the primary factor when making an investment decision. He prefers to look at the evidence in the form of numbers as opposed to explicitly looking for competitive advantages, which can lead to finding Moats that simply do not exist in a meaningful way. One key takeaway for investors is that they should spend a significant amount of time looking for businesses with great consistency in earnings growth, and finding data that supports a clear rationale as to why this growth is occurring.  

Let Opportunities Drive Your Investment Style

Many Investors today define their Investment strategy by one approach such as Value, Growth, or Event Driven. Buffet transcended these themes and instead  matched his investment strategy to market conditions and his personal investment setup. Over the years, his investment philosophy has evolved depending on the conditions that were present at the time. Below are three investment strategies that have helped buffet amass a great amount of wealth.

A)     General – These were securities he considered significantly undervalued compared to their intrinsic value. Buffet knew that there was no definite timeline for when this undervaluation would be corrected, but over time he expected that as a whole these investments would appreciate. He also expected them to have a significant ‘Margin of Safety’ which meant when markets declined, they would decline significantly less.

B)     Workouts – These were investments that depended less on how the market performed and more on corporate actions such as Mergers, Liquidation, Re-organizations, or Spin-offs. These investments also came with a lot of predictability seeing that there is a predetermined timeline that is in line with the Corporate Action.

C)     Control Situations – These opportunities presented themselves when a partnership can either control a company or own a large enough stake to actively influence operations. The primary objective of this strategy is to influence a company and unlock hidden value in assets, working capital or operational improvements.

It’s All About Management

While other renowned investors spent little time assessing management, Buffet dedicated his time to understanding and evaluating a company’s management. In many cases, Buffet had been assessing management and their ability to execute on ideas for years before his investment. One criterion he clearly looks for is a history of operations success. One of his core beliefs were that management should have the utmost integrity, otherwise they may hurt investors far more by being smart than by being dumb. He believed that good management was more than being able to allocate capital wisely but also being conservative with your available funds. In every company, management sets the tone for growth from the top, and he clearly considers their strength as one of the most important criteria in finding a good investment.

Conclusion

Being able to replicate Warrant Buffets success is no easy task. Nevertheless, studying the timeless lessons that can be drawn from his activities and strategies can be immensely insightful and rewarding. I caution every investor to have a thorough understanding of each investment opportunity that presents its self. The markets can be extremely unforgiving to amateurs but being able to get sound advice from an Investment Advisor or Portfolio Manager can allow you to  grow your wealth for generations to come.

- Kondwelani Kalinda, Licensed Assistant

Kondwelani Kalinda is a Licensed Assistant at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Kondwelani Kalinda who is a Licensed Assistant for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.