10 Warren Buffett investment strategies explained

Buffett, also known as the Oracle of Omaha, follows certain investing guidelines predominately based on the value investing approach he learned from Benjamin Graham, author of the investing classic, The Intelligent Investor.

Buffett’s investing strategies are widely documented and followed because of his long-term success in the stock market. Through his investments in Berkshire Hathaway, the company has grown 129,184% since 1980. Compare that with the S&P 500, which has grown 11,527% (dividends re-invested). That’s about 12% per year (annualised) for the S&P 500 and close to 20% for Buffett’s investments. Buffett runs Berkshire Hathaway with long-time business partner Charlie Munger.

At 91 years of age, Buffett is regularly named one of the richest men in the world, with an estimated net worth of $100bn. He has pledged to give away 99% of his wealth to charity. As of mid-2020, he has donated more than $37bn, according to Reuters​.

While Buffett follows a value investing (or fair value for growth) philosophy, by breaking the strategy up into parts, we can get an idea of the fundamentals he may be looking for in the stocks he and Charlie Munger purchase. Here are some of the key things a value investor would look for in individual stocks.

The margin of safety is the difference between the entry price and the company’s intrinsic value​ or what its assets are worth. Buffett is a value investor, so if he sees an attractive valuation for a solid company, he believes it’s worth purchasing. How to tell if a company is “solid” is discussed in the points below. The Intelligent Investor, written by Buffett’s mentor, is all about investing with a margin of safety based on stock valuations.

People think of Buffett as a long-term investor, but that is only true if the company keeps performing well and remains solid. If risks begin to outweigh the potential reward, or it becomes questionable whether the company will continue to do well, then the position is closed.

Strong stocks with good fundamentals will weather the volatile storms that occur. The larger gains occur as a result of compounding over many years. If a company is doing well in terms of its financial performance, Buffet would advise to stick with it instead of getting out every time the stock indices decline. The long-term trend of the stock market is up, and strong financial companies ride or lead that uptrend.

Buffett refrains from buying companies such as gold miners that don’t have a distinguishable product or a competitive advantage over the competition. Instead, he prefers companies such as Apple (AAPL), which have a distinct brand that people like. This is called an economic moat: a strong brand presence or USP that makes it hard for others to enter the same industry and compete.

Divide net income by net sales to get a profit margin. Healthy profit margins mean there’s a bigger buffer between making and losing money. If profit margins are small, even a tiny increase in costs, or reduction in sales price, could mean the product or service begins to lose money. Buffett looks to buy companies with the highest profit margins in an industry, as long as they also match his other buying parameters.

Buffett prefers lower debt relative to company equity. Shareholders’ equity is on the balance sheet. Debt means interest, and lots of debt means lots of interest payments and increased risk. Debt-to-equity is total liabilities divided by shareholders’ equity. There is no magic number because certain industries will have a greater or smaller amount of debt. What matters is the debt-to-equity comparison against industry peers. The lower the debt-to-equity relative to the competition, the better.

Revenues that increase over several years show that the company has the ability to keep increasing prices, selling more products or gaining more subscribers to its services. Increasing revenues tend to show a healthy business. While overall increasing earnings per share are also important if earnings are increasing without revenue also rising, the earnings may be coming from accounting tricks or temporary situations. When both show a consistent rise over 10 years, that may be better.

This is the catalyst that drives the company that Buffett runs, Berkshire Hathaway. Buffett’s favourite long-term investments​ are in companies that don’t pay a dividend (or pay only a small one), make money, and then keep that money within the business. This is called retained earnings and is what a company uses to grow. Some great companies choose to pay out profits in dividends. That is fine, but that also means the company can’t use those funds to grow. The real long-term successful companies invest in themselves, and that shows up in retained earnings.

Strong companies have money, and when they don’t have opportunities to grow, they can use the funds to buy back shares. If they make the same earnings, but there are fewer shares outstanding, that will mean higher earnings per share. Companies that regularly issue more shares are less stable. They are diluting EPS.

While these are characteristics Buffett looks for individual stocks. He is also a fan of low-cost index funds​ for people who don’t have the time or energy to analyse their investments carefully. Buffett admitted that he didn’t know much about new technologies coming out, so he didn’t invest in those companies.

Buffett has made huge profits on many investments in his long career. Here are a few of the biggest ones.