Is it a Warren Buffett action or not? 5 simple questions to ask yourself.
There’s a reason so many investors want to own Warren Buffett stock.
The so-called Oracle of Omaha has beaten the market in its long history as an investor. Berkshire Hathaway (BRK.A 2.49%) (BRK.B 2.15%) almost doubled the annual return of the S&P500 for nearly 60 years, and through the magic of compounding, that means Berkshire has returned more than 100 times what the S&P 500 has during that time.
Fortunately, for investors, Warren Buffett’s playbook is wide open and he has made it clear which types of stocks he prefers. Here are five simple questions to ask to determine if a stock would get Buffett’s stamp of approval.
1. Does it have an economic moat?
Perhaps Buffett’s favorite concept in all investing is the “economic moat,” or what most investors call sustainable competitive advantage. Buffett once said, “The most important thing [is] trying to find a company with a wide and lasting moat around it, protecting a formidable economic castle with an honest lord in charge of the castle.”
As alluded to in this statement, this key attribute protects the company from competitors. Buffett likes stocks with well-known brands such as Coca Cola Where Apple; businesses with limited competition and barriers to entry, like the BNSF railroad he acquired a decade ago; or companies with a strong market share and recurring revenue, such as GEICO.
If you want to know if it’s Buffett stock, ask yourself if the company can hold up against the competition for a long time.
2. Does it generate money?
Buffett doesn’t usually waste his time on unprofitable growth stocks. He looks for businesses that generate cash.
Buffett likes to own businesses like insurers that produce cash premiums before claims. He calls it a “float” that allows him to reinvest that money in stocks. He also likes sectors like energy (for example, Chevron inventories), which generate high cash flows when oil prices rise. Buffett is a fan of banks and financial companies like Bank of America and American Express which generate reliable profits through business loans, and he is known for investing in utilities and health care, which tend to generate steady cash flow.
What you will find among almost all Buffett Stock that they produce reliable cash flows and that many of them pay a dividend.
3. Does he have a long professional experience?
Warren Buffett doesn’t usually follow the latest trends, whether it was dot-com stocks in the 1990s or cloud software stocks more recently.
Instead, he prefers owning businesses with long histories and operating histories. Often he has studied these companies for years or is familiar with their brands. With Coca-Cola, for example, he had seen success for 50 years before becoming an investor. When Buffett decided to invest in technology, he bought stocks in IBM, because he had followed it for decades and understood the business. While this investment was unsuccessful, it nonetheless reflects Buffett’s approach of studying a business for a long time.
Similarly, in the financial sector, he prefers traditional banks to fintech, as banks have proven their business models over long periods of time. Not only are they less risky, but they also generate reliable cash flow.
4. Does it outperform in bear markets?
Historically, Berkshire has best demonstrated its mettle during bear markets. Buffett hoards cash to buy stocks when they’re cheap, and he’s been known to take advantage of the selloffs like during the financial crisis when he took a high-yielding stake in Bank of America preferred stock. Berkshire has also outperformed the stock market by a wider margin in bear markets, including this year.
Because many of Buffett’s favorite stocks have stood the test of time, they tend to do well in bear markets, and many of his favorite industries — including consumer staples, insurance, utilities and health care – are known to be recession-proof.
Buffett doesn’t exclusively buy recession-proof stocks. He owns cyclical stocks in sectors like energy, banking and industrials, but in general he prefers to buy stocks that can outperform in bear markets or have at least demonstrated an ability to recover from them.
5. Is it good value for money?
Finally, Buffett is a classic value investor. He wants to buy stocks that are trading below their intrinsic valuewhich is usually estimated using a discounted cash flow model.
The quality of the company is more important to the Berkshire chef than the price. He said, “It’s far better to buy a great company at a fair price than a fair company at an exceptional price.”
However, if he finds a stock he likes, he will only buy it if he thinks it is good value at the current price. In the bull market of the 2010s, Buffett often lamented that stocks got too expensive. With prices now falling, it wouldn’t be surprising to see Berkshire roll out its cash hoard, which is currently worth more than $100 billion.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. American Express is an advertising partner of The Ascent, a Motley Fool Company. Jeremy Bowman has no position in the stocks mentioned. The Motley Fool holds and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $47.50 long calls in January 2024 on Coca-Cola, $120 long calls in March 2023 on Apple, short calls of $200 in January 2023 on Berkshire Hathaway (B shares), short calls of $265 in January 2023 on Berkshire Hathaway (B shares) and short calls of $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.