Warren Buffet

Warren Buffet's Six Investment Principles

So how does he do it, buying companies and investing on the cheap?

Well in short, he keeps it as simple as possible and he's incredibly patient, moving only when the markets are so far in his favor that he can hardly lose. And of numerous books have been written about him, a few of his many tenets for successful investing stand out.

These are a few of them; investment questions that when answered properly have helped Buffet cement his reputation as the best in the business.

They are:

Has the company's performance been consistently good?-Buffett's tool in this regard is return on equity or ROE. Return on equity is a company's net income divided by shareholders equity (book value). Buffett uses ROE as a measure of company has consistently performed over time vs. its peers. A good ROE in this regard would be a 5 yr. average between 15-17 percent.

Does the company carry too much debt compared to its peers? ---The measure of debt Buffett uses in evaluation is the debt/equity ratio. Buffett, in general, frowns upon companies with high levels of debt. Instead he prefers that earnings growth is generated by shareholder equity as opposed to borrowed funds. In this case, the higher the ratio, the more debt that a company carries. And while this figure varies from industry to industry, a good way to measure it would be by looking for a ratio that is less than 80% of the industry average.

 

Are profit margins high compared to its peers? Are they increasing?-Buffett looks for companies with above average profit margins. It's calculated by dividing the net income by the net sales. Companies with a strong history in this regard over an extended period of 5-10 years typically outperform. An above average performer will typically carry profit margins that are 20% above the industry average. Moreover, those same profit margins will tend to rise as the company becomes more efficient over time.

How long has the company been public? -In general, Buffett typically only considers companies that have been around for at least 10 years. That gives them the historical track record to make a proper evaluation of the company's future prospects.

Are the company's products vulnerable to "commodity pricing"?-Buffett is a strong believer in the economic moat. Therefore, if the company doesn't offer anything that is unique or substantially different from its competitors he's generally not interested. 

And finally, is the company cheap on a valuation level? This is the part of the Buffett magic that is hard to quantify because it deals with a company's intrinsic value. That's the value that goes beyond its liquidation value and includes all the many intangibles that are hard to put a figure on, such as the worth of a brand name. In general, Buffet will want to purchase a company that is available at a 25% discount to its intrinsic value.

These, of course, are just a few of the many ways that Warren Buffet has built up his massive portfolio over the years. That's because to a large extent, Buffet never buys stocks, he buys companies.

The difference between these two styles has not only made him wealthy, but has also made him the best brand on the market today.

When he speaks, the markets follow.