Feeling inspired to invest like Warren Buffett and wondering what is the secret formula behind his success? Guess what – you don’t need to do anything extraordinary to be like the Oracle of Omaha. In fact, many people are surprised at just how uncomplicated and straightforward his investment style is. Personally, I am a big fan of his philosophy and there are so many gems that I uncover through his insights and sharings.
Warren Buffett is often regarded as the world’s greatest value investor. To sum up his investing principles in one sentence – always look for quality companies at fair value.
Warren Buffett: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Buffett follows economist’s Benjamin Graham school of value investing, which looks for quality companies whose prices are unjustifiably low based on their intrinsic worth.1
Qualitatively, these companies usually possess very strong economic moat due to their durable intangible assets. These intangible assets are usually not easily duplicated by their competitors, coupled with an ability to constantly innovate. In some instances, these companies also have high barriers to entry.
Intangible assets include strong brand recognition, coupled with innovation, network effect and customer loyalty, which tends to translate into strong pricing power. These attributes enable companies to be able to maintain their profits, even when facing less than desirable economic conditions.
Quantitively using financial metrics, quality companies often display sustainable high returns on capital employed/invested capital, high gross margins and are able to generate consistent large amounts of free cash flow year on year.
When using valuation as a key consideration, one shouldn’t buy companies at any price; only at a fair price. When valuing quality companies, one should refrain from falling into the trap of using shortcut methods like low Price-to-Earnings (P/E) Ratio and Price-to-Book (P/B) Ratio to determine whether the companies are “cheap”.
Discerning investors should instead look into whether the companies are able to reinvest their earnings at a sufficiently high rates to justify their relatively higher P/E or P/B, and also to factor in the quality of their business earnings. One of the metrics that we can use is the free cash-flow yield, which we can compare with the long-term 10 year treasuries and free cash-flow yield of other companies.
Warren Buffet: “I insist on a lot of time being spent, almost every day, to just sit and think.” We all know about the magic of compounding interest. Not only does it apply well to investing, it is also important to regard knowledge as something that compounds over time. To grow your investing know-how, you can connect with me for a light-hearted conversation anytime!