If you are an active investor, then you’ve likely heard the name Warren Buffett once or twice, given that he’s one of the greatest investors of all time.
His company Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) has beaten the broader market handily since Buffett took over the firm in 1965. A big part of Berkshire’s outperformance is thanks to its large equities portfolio now valued at more than $322 billion, where Buffett and his investing team buy and sell individual stocks.
When choosing individual stocks, retail investors can learn a lot from the Oracle of Omaha’s investing strategy. They should take Warren Buffett’s advice and buy stocks with these three attributes.
1. Consistent performance
The first thing Buffett looks for is whether or not the company he is interested in has a solid track record when it comes to financial performance.
One of the ways Buffett evaluates this is through return on shareholder equity (ROE), which is defined as net income divided by equity, and profit margins, which looks at how much of a company’s revenue becomes profit. The goal is not to find a company that can generate a strong ROE or profit margin once, but one that can do it over and over and through a variety of different economic environments.
For instance, one of Berkshire Hathaway’s largest holdings, the credit card and payments firm American Express (NYSE: AXP), has generated above a 12% ROE for the last decade, and many times that ROE was 25% or above. Meanwhile, Apple (NASDAQ: AAPL), which is by far Berkshire’s largest holding in its portfolio, has had over a 20% profit margin since 2010.
Buffett has been a great value investor over the years; he purchases stocks trading below their intrinsic value that the market has either ignored or perhaps doesn’t understand, but that will trade up to or above their intrinsic value over time.
Now, there is a method to the madness, and Buffett and Berkshire do not simply look for stocks trading at bargain valuations. As Buffett once wrote in a letter to shareholders, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
That means don’t let valuation blind you. If something is trading at a huge discount to its book value, there is likely a good reason for the discount. Instead, it’s a better idea to find a company that is great and that you can buy at a fair valuation, which will serve you better long term.
One example is Bank of America (NYSE: BAC), the second-largest holding in Berkshire’s portfolio. Bank of America currently trades at about 160% of its tangible book value, which is hardly a discounted bank stock valuation, especially in today’s market. But Bank of America is now the second-largest bank by assets in the U.S., is highly profitable, and has developed a strong moat with its deposit and lending franchise. Long term, Buffett believes this is still a very fair valuation at which to own the stock.
3. An impenetrable brand
Another theme you will see among many of Berkshire’s holdings is incredibly strong brand power. Think Apple and Coca-Cola (NYSE: KO). Now, why does Buffett like strong brands? It’s not because of the funny commercials.
The real reason is that strong brands provide these companies with a tremendous amount of pricing power. This comes in handy in times of high inflation like the one we are in today. Even though Apple’s or Coca-Cola’s cost of doing business has gone up, their strong brands allow them to raise the prices of their products without too much pushback from consumers.
Think about the iPhone and what a big part of people’s lives it has become. If the price of an iPhone goes up $100, most consumers are still going to buy it anyway, especially if they’ve been with the brand for a while. And how many times have you heard somebody say they will never drink Pepsi over Coke?
Even if Pepsi happens to be cheaper, odds are that if a person has a choice between the two, they are still likely going to pick Coke. Companies with this kind of branding power can be great long-term stocks to own.
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American Express is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has positions in Bank of America. The Motley Fool has positions in and recommends Apple, Bank of America, and Berkshire Hathaway. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway, long January 2024 $47.50 calls on Coca-Cola, long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway, short January 2023 $265 calls on Berkshire Hathaway, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.