Commonly referred to as "The Oracle of Omaha" due to
his Nebraska roots, Warren Buffett is widely regarded as the world's
most prominent value investor. Thanks to an ability to spot undervalued
companies and purchase them on the cheap, Buffett has made many
people very wealthy over the course of his five-decade career. Buffet's
38% stake in Berkshire Hathaway gives him a net worth of more than
$32 billion, making him the second-wealthiest man in the world (behind
only Bill Gates). He is also one of the very few who has amassed
such astonishing riches almost exclusively through stock market investments.
Buffett caught the investing bug at the University of Nebraska,
where he read Benjamin Graham's "The Intelligent Investor." Graham's
book advised investors to seek out stocks that trade far below their
actual value, that deliver a margin of safety and that sell below
their intrinsic value.
Buffett thoroughly researches businesses and only buys them at discounted
prices. This practice, which was essentially invented and
defined by Graham, gives him a so-called "margin of safety" on
all of his investments. This margin of safety is the difference
between a business' intrinsic value and its share price.
Buffett invests in businesses with superior economic characteristics
that are controlled by successful, skilled management teams. He also
looks for companies with long histories of above-average earnings
growth. And unlike many other investors, Buffett does not pay attention to stock market fluctuations,
macroeconomics and market predictions. Instead, he merely sticks
to his long-term investing plan. As long as a firm's fundamentals
do not change, Buffett will not sell -- even in times of economic
crisis.
Below are a few other characteristics that Buffett looks for
when evaluating an investment opportunity.
Easy-to-Understand Businesses
One of Warren Buffet's principles is not unlike Peter Lynch's --
stick with what you understand and choose investments with which
you are comfortable. Buffett, arguably one of the greatest and most
revered stock-pickers of all time, says investors shouldn't complicate
things by seeking out complicated companies.
Along those lines, the world's savviest investor has kept Berkshire Hathaway away
from fast-growing technology stocks.
Buffett admits that he just doesn't understand technology
well. As such, he avoids the industry altogether. Before investing in any business,
Buffett attempts to predict what the company will look like 10 years in
the future. High-tech markets change too fast to look that far ahead with
any confidence.
High Return on Equity (ROE)
Buffett emphasizes return on equity (ROE), a key measure of a company's
profitability. He prefers to invest in companies where he
can confidently forecast future ROEs at
least 10 years out. He is particularly fond of firms that don't
require a lot of capital, as they tend to produce much higher
returns on equity.
Consistently Strong Free Cash Flow
Buffett also seeks companies with significant free cash flow.
Always mindful of the risks associated with investing, he ensures that
his companies have plenty of money left over to
invest in their growth after they have paid the bills.
Limited Debt
In the 1990s, Buffett bought insurers Geico and General Re because
he liked how the companies limited and managed their debt.
Buffett also likes the "float" that insurance companies offer. Policyholders
pay premiums up front, but claims are paid out later -- providing insurance
companies with a steady stream of low-cost cash to play with. Until
policyholders collect on their policies or claims, the company can
invest those billions in stocks/bonds or other areas, and who better
to invest that money than Buffett himself?
Quality Management
Among the most noteworthy aspects of Buffett's stock-picking expertise
is that he looks for quality companies with quality management
teams. When Buffett buys a business, he buys its management as well.
Buffett looks for people who are as passionate about their business
as he is about investing.
Income Security
of the Month
Our "Income Security of the Month" for August 2008 invests in a
fast-growing overseas market that doesn't get much exposure in the
mainstream financial press. And although it typically makes enormous
annual dividend payments -- it has paid an average dividend of
25.5% per year over the past five years -- this fund is perhaps
most appealing for its total return potential. Specifically, the
fund has delivered total returns of +178.9% since 2003,
and it ranks in the top 10% of its category over the past decade.
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