News Analysis date published New: 
Tuesday, October 16, 2012 - 11:30
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Tuesday, October 16, 2012 - 11:30
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Tuesday, October 16, 2012 - 11:30

Buffett Built His Empire Using This Simple Method

Tuesday, October 16, 2012 - 11:30am

It might be one of the most controversial statements I've ever made. You aren't likely to hear anyone else say it, as it goes against one of investors' longest-held beliefs.

I think diversification actually hurts your returns.

I'm not saying you should have a portfolio of just two or three holdings. But at the same time, I'm not at all concerned with having a portfolio of dozens of holdings that represent every sector of the market.

After all, it's impossible to outperform the market if your portfolio is the market.

Instead, I think investors should focus exclusively on their very best ideas. The ideal way to do that is to own a basket of no more than 20 or 30 of the world's greatest businesses. I only say that many because I don't think individual investors should put more than 5% of their money in one stock.

Still, those 20 to 30 companies should be the best companies you can buy.

And I'm not alone in thinking this way...

Consider that Warren Buffett's Berkshire Hathaway's (NYSE: BRK-B) top five holdings make up 75% of his company's portfolio.

"If it's your game, diversification doesn't make sense. It's crazy to put money into your 20th choice rather than your 1st choice. It's the 'LeBron James' analogy. If you have basketball phenom LeBron James on your team, don't take him out of the game just to make room for someone else."

- Warren Buffett

Of course, you know how successful Warren Buffett has been in beating the market. But he's not alone...

For instance, I've found something I call the "WGB Retirement Fund." It consists of only 12 stocks, but it's beaten the market for the past 1, 3, and 5-year periods... and has nearly tripled the S&P over the past decade. (Haven't heard of the "WGB Retirement Fund"? You can visit this link to learn more.)

Of course, all of this begs the question. If you're going to invest in only a handful of stocks... which ones should you buy?

I like to own what I call the "World's Greatest Businesses." These are the kind of companies that dominate their market and reward shareholders each and every year with billions of dollars in dividends and share buybacks (along with several other traits I'll share in just a moment...)

Take a company like Coca-Cola (NYSE: KO), for example. It's without a doubt one of the World's Greatest Businesses.

When most investors think of Coca-Cola, they think there is no money to be made. After all, it's a large company, it has been around for more than 120 years, and its best days of growth are seemingly behind it.

But the numbers tell a different story...

During the past decade, Coke's dividends have increased 155%. Its per-share earnings are up 149%. And most importantly, the stock has nearly doubled its investors' money during one of the most turbulent periods in market history. Not bad for a company whose "glory days" were supposed to be long gone.

To be fair, I think Coca-Cola is richly valued now. I wouldn't buy the stock at these levels, even though I think it's a great business.

But what makes a company like Coke one of the World's Greatest Businesses... allowing it to beat the market for decades? And more importantly, how can investors use this information to find other great businesses to own?

I've been actively researching this topic for several years, and during that time I've identified 11 traits that are consistent with the World's Greatest Businesses.

I urge you to print this list out, set it by your computer and consult it every time you're thinking about making an investment decision. I'm convinced it will make you a better investor.

1.) The World's Greatest Businesses sell their products at premium prices.

2.) The World's Greatest Businesses sell products used in day-to-day life.

3.) The World's Greatest Businesses have a global reach and appeal for their products.

4.) The World's Greatest Businesses are highly scalable.

5.) The World's Greatest Businesses sell things that consumers can't live without.

6.) The World's Greatest Businesses face little or no regulation.

7.) The World's Greatest Businesses have unlimited growth potential.

8.) The World's Greatest Businesses dominate their competition and have clear competitive advantages that keep rivals at bay.

9.) The World's Greatest Businesses generate enormous cash flow with low capital spending requirements.

10.) The World's Greatest Businesses return billions of dollars to investors in the form of dividends and share buybacks.

11.) The World's Greatest Businesses have extremely high profit margins, or at least margins that outpace their industry averages.

Now, it's rare that any company will have all of the characteristics I just listed.

For example, cigarette companies sell addictive, high-margin products. And as a result, companies like Altria (NYSE: MO) and Philip Morris International (NYSE: PM) have been some of the stock market's best performers... delivering gains of hundreds of percent over the years. On the other hand, both companies face stiff regulation.

Meanwhile, a fast-food restaurant like McDonald's (NYSE: MCD) has a scalable business, but it doesn't sell its products at premium prices. That doesn't mean it isn't a great business... or a great investment. McDonald's stock is up more than 300% in the past decade.

Action to Take --> So while few companies will meet all 11 traits, the more of these characteristics a company has... the more likely it is to not only beat the market, but continue earning you money year after year.

[Note: If you're interested in learning more about the "WGB Retirement Fund" I mentioned earlier, visit this link. This "fund" made of just 12 stocks is beating the market year after year... and some of America's largest pension funds are investing millions in these companies. Get the details -- including how you can invest in this "fund" today -- by following this link.]

Paul Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of MO, PM in one or more of its “real money” portfolios.