Here's How You Can Pick Great Stocks Just Like Warren Buffett

Warren Buffett is arguably one of the world’s best investors.

For the past 50-odd years, he has amassed a return of around 20% per year for the shareholders of his company, Berkshire Hathaway Inc.

That’s a phenomenal return considering the S&P 500 index produced a return of only around 10%, including dividends. 

One of Buffett’s most successful investments is The Coca-Cola Company (NYSE: KO). 

As of 30 September 2020, Berkshire’s investment in the soft drinks company was worth US$19.7 billion at a cost of just US$1.3 billion. This translates to a gain of an over 1,400%!

Including dividends, the returns would be much higher, considering Buffett first bought the stock in 1988. 

Double wow!

TL;DR: Picking Winning Stocks the Warren Buffett Way

Warren Buffett has four simple criteria when it comes to picking stocks. For a stock investment to win, the business:

1. Must be simple to understand;
2. Must have excellent long-term prospects;
3. Must be run by honest and competent folks; and
4. Must be attractively priced.

What’s The Secret Behind Such Astronomical Returns?

In his 1977 Letter to Shareholders, Buffett revealed how he picks stocks (emphases are mine):

“We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety.

We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.

We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.”

Analysing Coca-Cola Based On Warren Buffett’s Musings

Based on the first criteria, Coca-Cola is a simple business to understand. It simply sells sugary drinks to consumers.

The red can is one of the world’s most well-known products, and when Buffett bought the stock, sales overseas were going off the roof.

The annual report of Coca-Cola in 1988 showed the following (emphases are mine):

“In 1988, more than 200 billion servings of our soft drinks were sold worldwide. No other company sold even half as much.

On a competitive basis, our position as the world’s only truly global soft drink company grew stronger. Our market share of the world’s flavored, carbonated soft drink sales, excluding China and the Soviet Union, climbed to nearly 45% – an all-time high – reflecting the talent, diligence and dedication of our Company associates and the people of our worldwide system.”

Buffett also liked the person behind the business. His name was Roberto Goizueta.

In Berkshire Hathaway’s 1989 Letter to Shareholders, Warren Buffett praised Roberto, saying:

“Through a truly rare blend of marketing and financial skills, Roberto has maximized both the growth of his product and the rewards that this growth brings to shareholders. Normally, the CEO of a consumer products company, drawing on his natural inclinations or experience, will cause either marketing or finance to dominate the business at the expense of the other discipline. With Roberto, the mesh of marketing and finance is perfect and the result is a shareholder’s dream.”

In terms of valuation, Coca-Cola had diluted earnings per share of US$2.84 in 1988 and was trading at $44.60 then, giving a price-to-earnings (P/E) ratio of around 16x. Coca-Cola’s valuation was not demanding, considering the exponential growth that it had then.

The key to investing success is not just purchasing well, but also holding on to a company for the long-term. Over the many decades Buffett had invested in Coca-Cola, its share price had been on a volatile ride.

However, Warren Buffett didn’t bail out on the first sight of weakness. He held on to Coca-Cola’s shares through the various ups-and-downs, and, wait for it….

…he has never sold a single stock all these years. 

Key Learning Points

Behind every ticker symbol is a living, breathing business. 

Our goal as an investor should be to purchase a partial stake in a simple business that is selling at a reasonable price, whose earnings would be materially higher many years from now, and run by people with competence and integrity. 

We would do reasonably well in the stock market if we are disciplined and patient enough to follow the not-so-secretive secret of the world’s third-richest guy. 

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Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. ​Readers should always do their own due diligence and consider their financial goals before investing in any stock. The writer may have a vested interest in the companies mentioned.