Do you know how Warren Buffett invests in stocks

26 07 2009
Do you know how Warren Buffett invests in stocks ?

Here lists down the factors on how Buffett finds low-priced value by asking himself some questions when he evaluates the relationship between a stock’s level of excellence and its price.

1. How Long The Company Has Been Established ?
Preferable the company should have been established for at least 10 years. The reason for this factor is that the company has stood the challenging economy hard time.

2. What Are The Company’s Products Portfolio?
What are the company’s products ? Are the products different than another firm within the same industry. Any products or features that are hard to replicate is what Buffett calls a company’s economic moat, or competitive advantage. The wider the moat, the tougher it is for a competitor to gain market share.

3. Is The Stock Intrinsic Value 25% Higher Than The Market Capitalization ?
Find the companies that are undervalued by determine the intrinsic value of a company. Intrinsic value is dereived from the elements such as earnings, revenues and assets.

Buffett likes to determine the intrinsic value of the company as a whole and compares it to its current market capitalization. Buffett sees the company as one that has value if intrinsic value is at least 25% higher than the company’s market capitalization.

4. Has the Return On Equity (ROE) Consistently Performed Well?
Return on equity (ROE) is likes the stockholder’s return on investment (ROI) that reveals the rate at which shareholders are earning income on their shares.

Buffett always looks at ROE to see whether or not a company has consistently performed well in comparison to other companies in the same industry.

ROE = Net Income / Shareholder’s Equity

You will need to know the past five to 10 years ROE in order to have a better idea of historical performance.

5. What is the debt/equity ratio ?

Debt/Equity ratio = Total Liabilities / Shareholders’ Equity

This ratio shows the proportion of equity and debt the company is using to finance its assets, and the higher the ratio, the more debt is being used to finance the operation of the company.

Buffett prefers to see a small amount of debt so that earnings growth is being generated from shareholders’ equity as opposed to borrowed money.

The reason why prefer a small amount of debt is to reduce the volatility of the company earning and to avoid paying too much interest expenses. For a more stringent test, investors sometimes use only long-term debt instead of total liabilities in the calculation above.

6. Profit Margins and Trends

Profit Margins = Net income / Net sales.

Company that shows good and increasing profit margin is better. Again better to have the past five to 10 years profit margins record in order to have a better idea of historical performance.

Company that executes its business well will lead to the high profit margin. Efficient company management level will bring to the increasing margins by controlling the company expenses.

Are you following this methods in your stock selection criteria ? Anyway, those are not the only things Buffett analyzes but rather a brief summary of what Buffett looks for.

If we wish to invest successfully like Buffet, shouldn’t we follow his system or methodology since he has proved himself by becoming the world second richest man through investing.

Many books had been published that reveals the system or method of how Warren Buffett select the stocks. One of it is The Buffett System ebook that costs US 49 or around RM 177.

If you are interested and wish to have a try on this system, do visit the Buffett System to find out more information.



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