Warren Buffett Investment Approach

Buffett's philosophy on business investing is a modification of the value investing approach of his mentor Benjamin Graham. Graham bought companies because they were cheap compared to their intrinsic value. He was of the belief that as long as the market undervalued them relative to their intrinsic value he was making a solid investment. He reasoned that the market will eventually realize it has undervalued the company and will correct its course regardless of what type of business the company was in. In addition he believes that the business has to have solid economics behind it.

The following are some questions to determine what business to buy, based on the book Buffettology by Mary Buffett:

• Is the company in an industry of good economics, i.e., not an industry competing on price points.
  Does the company have a consumer monopoly or brand name that commands loyalty? Can any company with an abundance of resources compete successfully with the company?
  
• Are the earnings on an upward trend with good and consistent margins?
  
• Is the debt-to-equity ratio low or is the earnings-to-debt ratio high, i.e. can the company repay debt even in years when earnings are lower than average?
  
• Is ROE consistent over its history, more than 12%, and high compared to the industry average? Or does the company have high and consistent Return on Total Capital?
  
• Does the company retain earnings for growth?
  
• The business should not have high maintenance cost of operations, low capital expenditure or investment cash outflow. This is not the same as investing to expand capacity.
  
• Does the company reinvest earnings in good business opportunities? Does management have a good track record of profiting from these investments?
  
• Is the company free to adjust prices for inflation?
  

Buffett's next concern would be when to buy. He does not hurry to invest in businesses with undiscernible value. He will wait for market corrections or downturns to buy solid businesses at reasonable prices, since stock-market downturns present buying opportunities. He is conservative when greed and speculation is rampant in the market and he is greedy and aggressive when others are fearing for their capital. This contrarian strategy is what led Buffett's company through the Internet boom and bust without significant damage, although critics have also noted that it may have led Berkshire to miss out on potential opportunities during the same period.

Then he asks at what price is the business a bargain, and his answer typically is when it provides a higher rate of compounded return relative to other available investment opportunities.

Buffett has coined the term "economic moat," preferring to acquire companies that possess sustainable competitive advantages over their competitors.

Warren Buffett's letters to shareholders are a very valuable source in understanding his investment style and outlook.

From warrenbuffett.com