This is the secret Warren Buffett stock picking formula that has helped investors build long-term wealth and beat the market over and over again.
KISS is one of those acronyms that can sound a bit harsh. Keep It Simple, Stupid isn’t necessarily the nicest thing to say to someone. There’s some real wisdom there, though, that applies to plenty of things in life. The implication is that there’s no need to turn something simple, that works, into something unnecessarily complicated. A sunny day at your local baseball diamond with a plate of nachos and a cold beer is one of the true joys of life. It’s simple – and perfect.
One unnamed stadium, however, decided that Apple Pie Nachos would be a good idea. Apple pie filling on cinnamon-flavored chips, topped with whipped cream, caramel, and cheese. Um… no, thank you.
What does that have to do with the Warren Buffett stock picking formula and filling your bank account with cash? More than it may seem, believe it or not.
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The surprisingly simple Warren Buffett stock picking formula
When Warren Buffett started his own investment company in the late 1950s, his initial investments in Berkshire Hathaway, a textile manufacturing company based in New Bedford, Massachusetts, and GEICO General Insurance Co. became huge successes and provided the foundation to generate large investment profits and cash flows. The profits and cash flows were then invested in additional stocks. This simple formula snowballed into millions and then billions of dollars in capital under management.
That formula has seven simple steps:
- Be Patient. Wait for the right time to buy. Patient investors are the best prepared when opportunities emerge. Because of market turbulence, stocks of great companies become available to trade at very cheap valuations. This doesn’t mean buy stocks and forget about them! Tracking performance is key and so is getting out when necessary (when your stock is overvalued or trouble is on the horizon). Invest only in companies that will outperform for decades. Follow this approach and you will gradually develop an outstanding stock portfolio like Warren Buffett.
- Buy Companies at Bargain Prices. Warren Buffett is a true value investor. Buying companies cheap is what value investing is all about. Purchase stocks below their intrinsic value and fill your portfolio with these companies. Pay less attention to earnings per share. Look for solid return on equity, high operating margins and low debt. In addition, look for companies that generate lots of cash and have a consistent operating history during the past 10 years.
- Go Against Conventional Wisdom. Attempt to be fearful when others are greedy and to be greedy only when others are fearful. Going against the crowd can be an effective way to make money.
- Stick with What You Know. Stay within your circle of confidence. If you don’t understand what a company does or how it makes money, avoid it.
- Be Self-Confident. You must be able to act without affirmation from others (or the market) on your investment decisions.
- Buy Companies with Competitive Advantages. Warren Buffett calls this an “economic moat,” which gives a company barriers or protection from its competition. Examples of competitive advantages include high capital costs for rival companies to enter a business, a strong brand identity or patent protection.
- Believe in America. Warren Buffett has faith in the long-term prosperity of U.S. companies. This allows him to make investment decisions that are not based on where we are in economic cycles.
Don’t be fooled, however. The Warren Buffett stock picking formula is simple, but it’s not easy. Patience may be one of the most difficult concepts for investors. And there’s no question that you have to do some homework.
The secret behind the Warren Buffett stock picking formula
Buffett’s seven-part investing formula isn’t much of a secret these days. It’s a formula that most successful value investors follow. Behind that formula, however, is an interesting philosophy.
In an interview, Nicole Buffett, Warren Buffett’s granddaughter, talked about five sayings that her grandmother, Warren’s wife, used to drill into her kids and grandkids. They’re pretty basic, which is what you’d expect from a down-to-earth value-investing family, but they’re also pretty good.
- Show up.
- Tell the truth.
- Pay attention.
- Do your best.
- Don’t be too attached to the outcome.
Now, the first four are exactly the kind of sentiments you’d find embroidered on a satin pillow in your grandmother’s house. But number five is a more profound and unexpected piece of advice, and a great lesson for all investors.
Investing, especially growth investing, always requires a leap of faith. You can do all your homework on a stock, check the fundamentals, analyze the chart, read the coverage from analysts and commentators (and newsletters like ours), and calculate its potential for hours on end. But eventually you have to make the decision to push the buy button.
Do you have any additional tips or questions about value investing? Let us know in the comments. We’d love to hear your thoughts.
*This post has been updated from an original version, published in 2020.