Warren Buffett and investment strategies

Warren Buffett, known as the 'Oracle' or the 'Sage of Omaha', is generally considered to be one of the world's most successful investors. Berkshire Hathaway, the company he used as an investment vehicle, is now legendary for its achievements. Investors would love to find out what is the secret of his success, i.e. how he became America's second or third richest man, and a living legend.

Although Buffett does not give stock tips, he speaks from time to time about his investment principles in the annual letters to Berkshire Hathaway or stockholders, in reports to annual meetings and occasionally in the media.

A look at the history of Berkshire Hathaway could point out some of Buffett's strategies. After he took control of the company, Berkshire began operating in a dual role. The first role implied maintaining the core textile business. The second role was that of an investment vehicle, which Buffett gradually emphasized.

The textile business was in trouble and Buffett realized that instantaneously. Still, although the problems of the milling industry were constantly going up, Buffett persevered. He admitted that closing the plants would have severe effects on jobs and the community, so he continued to keep the factory open, despite its falling revenue rates. He stated at the time that he is not willing to close the factories just because the average profit is a little lower than the industry standard. This is a proof of Buffett's conservative nature, which would later bring him great successes.

However, as time went by, Buffett saw that it was impossible to keep the milling companies afloat, because of increasing foreign competition and structural costs. In 1985 he decided to discontinue Berkshire's historic role in the textile industry. Not even him could stop a structurally unprofitable company from collapsing.

The second role Berkshire Hathaway played was extremely important for Buffett's success. In 1967 he turned his attention towards the insurance business and purchased two Nebraska companies, National Indemnity and National Fire and Marine Insurance. The insurance business was risky, under permanent competition stress and in constant need of excellent management. Buffett was coming from a traditional sector of the economy, textiles, but the new challenge proved to be exactly what he had needed. The new opportunity gave him the chance to put his full potential to the test and to apply all the investment strategies that have made him famous.

Here are some of his ideas, picked up from his general investment strategy, the books published on his life and work and from the information provided by the media.

Buffett's investing philosophy resembles the one of the legendary Benjamin Graham. "The Intelligent Investor," by Graham, is one of the best examples of investing logic published in the last 40 years. Buffett has used Graham's philosophies to achieve his own investments successes.

The Oracle at Omaha looks for several things when he is buying a company or shares thereof.

The first thing that he is interested in is that the particular company is an industry leader which puts on the market essential products. Companies with a more-or-less monopoly on consumer loyalty are the ones Buffett likes the most.

The next thing Buffett looks for is financial performance. After all, that is what characterized his whole life as an investor. His insurance business, described above, is the best example of such a technique. Buffett only takes interest in companies that consistently beat the stock market's long-term annual return of 10%. After all, how could he have become so rich only by benefiting from the standard annual return rate?

Another quality that he seeks when he purchases a company is that the particular organization has an aggressive behavior, constantly looking for new opportunities and financing its expansion with its earnings. As a conservative investor (the fact that Berkshire Hathaway was initially a commodities company should not be forgotten), Buffett is interested in companies with a sound financial position and with conservative financing methods.

Buffett is always looking for consistency. He does not like organizations that gain a lot in some years and lose even more in others. He looks for a history of steadily increasing earnings, which indicate that the particular company is well and carefully managed. Buffett would consider the evolution on the Return on Equity and Return on Capital ratios in order to determine how the company has performed in the past. In 1977, he said that 'Since businesses customarily add from year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share.'

Buffett does not like debt, especially in the form of long-term debt, so he will not invest in companies with such characteristics. Long-term debt means that any increase in the interest-rate could seriously affect the company's profits and make future cash-flows unpredictable. Buffett said on one occasion, in 1987, that 'Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage. It seems to us both foolish and improper to risk what is important (including, necessarily, the welfare of innocent bystanders such as policyholders and employees) for some extra returns that are relatively unimportant.'

One of the most interesting features of Buffett's investing techniques is buying value companies at discounted prices, since the public thinks their best days are past. One of the best examples is the investment he did into Coca-Cola in the 1970's, when all other investors thought its heydays were over.

Of course that applying these principles involves a considerable amount of work and research. Warren Buffet takes a very long time before buying a company, since he analyses it from all points-of-view. Purchasing a business is a long-term affair for Buffett. When he decides to invest, he spends a lot of money and wants all of it to bring back even more.

People tend to think that, since Buffett is so huge an investor and since he is so rich, he must hold stock in many companies. Actually, and quite surprisingly, Buffett invests in remarkably few companies, when we think about his multi-billion dollar fortune. His carefully made analysis and his commitment to the companies he buys makes him want to hold a particular investment for many years, if not a lifetime. His wealth and the degree of security he imposes help him achieve this objective.