How to achieve the average annual return of 20% achieved by Warren Buffett?
Legendary investor Warren Buffett probably needs no introduction. His genius and investment wisdom has helped him and his Berkshire Hathaway to beat the performance of the S&P 500 over the long term, which just about anyone can do. Today, we'll look at a few of his basic strategies and ideas that can help you too to improve your performance and beat the S&P500.
Warren Buffett (Oracle of Omaha)
We all know the good old fable surrounding the great man's name, which is that Buffett has been beating the S&P 500 index for a long time. Better put - Buffett and his Berkshire have generated a compound annual return of 20.1% (since 1965) versus 10.5% for the S&P 500. This year, that return may not be as great, but that's due to the size of his Berkshire and not finding as many lucrative investments, plus macroeconomic influences.
As you can see, the curve is slowly approaching the performance of the S&P 500, but it is still slightly above it. The chart is only through 2015, but it's pretty similar now, i.e. Buffett's Berkshire slightly beats the S&P 500.
Warren Buffett is without a doubt one of the most respected investors of all time. Buffett's investment strategy is pretty simple on the whole, but even so, investors seek out all sorts of complexities and nonsense 👇
- Buy businesses, not stocks. In other words, think like a business owner, not someone who owns a piece of paper.
- Look for companies with competitive advantages that can be sustained or have so-called economic moats. Companies that can successfully fend off competition are more likely to increase intrinsic value over time.
- Focus on long-term intrinsic value, not short-term earnings. What matters is how much cash the company can generate for its owners in the future. Therefore, value companies using discounted cash flow analysis.
- Require a safety margin. Future cash flows are inherently uncertain. To compensate for this uncertainty, always buy companies for less than their intrinsic value.
- Be patient. Investing is not about instant gratification: it's about long-term success.
Of course, what is simple in theory may be less so in execution. These are just a handful of basic principles of greatness that can help you too in your quest for better appreciation.
But what does such an ideal company look like?
Here's a look at one of Buffett's quotes, " The key to investing is to pick the right stocks at the right time and hold them as long as the company is doing well."
- Buffett's view is that a company needs to be clear about what they offer - what their product is, how they do business. Every new investment is like the beginning of a new collaboration, that's how every investor should take it.
- Pay some attention to the management of the company. Watch their actions, their behaviour in difficult situations and, above all, focus on how they solve the problems. This will give you a lot of clues and you will not be unpleasantly surprised in the future when complications arise and you will know how the management solves the problem and how it proceeds.
- Buffett often focuses on basic and unpretentious products or a diversified income portfolio for a given company. Basically, he has long picked companies that wear out quickly or people have a need to buy over and over again. $PG-3.2%, $KO+0.3%, $MCD+0.7% and a number of others can serve as examples here.
- A strong market position is another important metric. Buffett prefers companies that have a significant name and position in the market. These companies are better able to withstand unpredictable events and competition. I would repeat myself here, but again, the stock selection fits - PG, KO and MCD - as you can see, they obviously meet the criteria.
- The Oracle of Omaha likes companies to buy back their own stock. It's a sign that management believes in the future growth of the company (this is not to say that when a company buys back stock that it is immediately right). Buffett is also interested in companies that can pass on cost increases to prices in order to maintain the same profit margins.
- Dividend stocks also play a role in Buffett's portfolio. Even before the pandemic, Berkshire was on track to generate $4.7 billion in dividend income (that number, of course, has declined). The bottom line is that even so, Berkshire has generated about $3 billion that it can use to make new investments or expand existing positions.
- History speaks volumes here - Companies that have paid and increased their dividends have seen greater growth in value. Comparable stocks that have not paid dividends have had much lower returns over the same time period.
I hope these basics help you to improve your performance and take away some insights or tweaks that you can easily apply yourself. This article is the next installment in my series where I focus and dissect the insights, strategies and tweaks of famous investors (if anyone is interested in this topic, definitely check out Peter Lynch's article on the rules). However, I'm not literally saying that an investor should copy their investments, strategies, or particular ''mapping'' of a given stock. It's great to learn from the greats, which may prove useful in the future. It is the investor (Buffett) who has been described as one of the best investors of all time who could bring you some inspiration and a lot of knowledge that you can use.
- Let me know in the comments if you would be interested in a follow-up that I would do in terms of the various parameters and criteria for stock selection according to Buffett. If there's interest, I'll follow up on this series next week.
Please note that this is not financial advice. Every investment must go through a thorough analysis.