Warren Buffett's 5 Favorite Stocks

Paul Tracy's picture

Wednesday, May 16, 2012 - 10:00am

by Paul Tracy

It might be the most controversial statement I've ever told investors...

In fact, you're likely to shrug me off at first, as what I'm about to tell you goes against everything you've been taught about wealth management.

But if you want to become wealthy in the stock market, then it might be the single most important thing you'll hear.

I think diversification actually hurts your returns.

I'm not saying you should have a portfolio of just two or three holdings. That's never a good idea. If one of those stocks heads south, then your entire portfolio would suffer.

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.

Think of it this way: Which do you think would average higher on a test... an entire class full of students, or a handful of the smartest students as picked by the teacher? The answer is obvious... and it's the same with your portfolio.

What may surprise you is that I'm not alone in thinking this way.

Warren Buffett's Berkshire Hathaway (NYSE: BRK-B) holds just 34 publicly-traded U.S. stocks. That's a lot for an individual investor, but for a company with billions at its disposal, it's surprisingly few. On top of that, Berkshire's top five holdings make up 75% of its portfolio.

Buffett's logic is simple. He simply believes investors should focus exclusively on their best picks.

"Once you're in the business of evaluating businesses, then I think diversification is a terrible mistake. If you really know businesses, then you probably shouldn't own more than six of them. I can tell you that going into a seventh [business] instead of putting more money into your first one is a terrible mistake. Very few people have gotten rich on their seventh-best idea, but a lot of people have gotten rich on their best idea."
-Warren Buffett

To be fair, Buffett says his strategy isn't for everyone. It takes experience to be able to identify which businesses make good investments... and which to avoid. But if you know what you're looking for, then it doesn't necessarily have to be that difficult.

See, when you're focusing on a small number of companies, you have to invest in businesses that will make money almost no matter what. You can't just buy and hold any stock and expect to come out ahead -- that's not the way the market works.

Instead, if you want to build a stable and reliable portfolio, then you need to focus on a handful of proven companies with a commitment to making you -- the investor -- wealthier.

Take Buffett's largest holding, The Coca-Cola Co. (NYSE: KO), for example. Coca-Cola is by no means an "exciting" stock. Its business is so simple, Buffett once said "a ham sandwich could run the company" and it would still be profitable.

But as the world's largest manufacturer, distributor, and marketer of non-alcoholic beverages, Coca-Cola is one of the most dominant companies on the planet. The company operates in more than 200 countries and owns the most valuable brand name in the world.

Across all of Coca Cola's products, the company commands 43% of the U.S. market share for non-alcoholic beverages. Even if a competitor wanted to compete with Coke, then it would be nearly impossible given Coca-Cola's expansive market presence.

These competitive advantages help support the company's share price in any market.

Better yet, Coca-Cola rewards shareholders by paying a steady (and increasing) dividend. The company has paid a dividend every year since 1893, which has been increased annually for the past 50 years.

These reliable dividend payments provide investors with a steady cash flow -- regardless of what the market is doing.

I want to be clear. I'm not telling you to run out and buy Coca-Cola. But as Berkshire Hathaway's largest holding, it does help prove my point. The best way to become wealthy in the market is to focus on those companies dominating their market, indispensable to daily life, and that also reward shareholders with dividends or share buybacks.

Action to Take --> All you have to do is find them... once you do, the strategy is simple. Just buy them, hold them, and let their steady and increasing dividends grow your wealth year after year for the rest of your life... or as I like to say, hold them "Forever."

Of course, with investing nothing is 100% certain. Even the strongest companies are vulnerable during a market sell-off.

But by investing in a handful the world's greatest businesses, you're building a portfolio whose strong performance can make you money... almost no matter what the market is doing.

[Note: For companies that dominate their markets and put investors first, don't miss the latest presentation over my Top 10 Stocks for 2012. One stock has raised its dividend 110% in five years... another has $8.25 per share in cash (45% of its share price)... another yields 8.0% while it has nearly doubled its net income year-over-year. These are the types of investments that make up my Top 10 Stocks for 2012 report.]

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