Billionaire Warren Buffett’s investment performance has been phenomenal. Since 1964, his portfolio of stocks and businesses has delivered a compounded annual gain of around 20%. And we know that because he sets out his performance in his annual letters to the shareholders of Berkshire Hathaway. The company is the vehicle via which he invests. And holdings in the conglomerate include entire businesses as well as the stocks of others.
Investing within his limits
And over those decades, Buffett built his ultra-successful approach on three primary and powerful investing rules.
The first is that he always stays within what he calls his “circle of competence”. And that means only investing in businesses he understands. If he can’t see a clear runway for multi-year growth, he’s likely to avoid an investment opportunity altogether.
And for many years, he avoided investments in the tech sector. The internet stocks of the past couple of decades largely past him by. And most of Buffett’s investments could be found among what we used to call old economy stocks. A glance at his current stock portfolio reveals names such as American Express, Coca-Cola, General Motors and Chevron.
In fairness, Buffett made a big bet on Apple in recent years and now owns around 5.6% of the company’s shares. But by then, the enterprise had more in common with consumer goods businesses than cutting-edge tech outfits, in my opinion. And that, I’m assuming, is an area Buffett knew well.
Value, of course!
The second rule is Buffett’s focus on value rather than on share prices. Value arises because of many factors. For example, the potential for a business to grow its earnings and assets in the years ahead can be an important part of value. And the way a company’s market capitalisation compares to its asset value and current earnings can be another.
Buffett looks for stocks that are undervaluing the true worth of a business. But a fallen stock price alone does not guarantee such a situation. Sometimes, stock prices deserve to be low or depressed. It’s possible for the worth of a business to decline faster than its share price, for example.
The waiting game
The third rule that Buffett invests by is patience. And that can mean patiently waiting for the market to offer him attractive opportunities. Or it can mean holding onto his stocks while they appreciate over time to reflect the underlying progress of a business. He has often said that after his careful selection of stocks and businesses, his favourite holding period is “forever”.
For me, Buffett’s three powerful investing rules are a useful way to approach the construction of my own stock portfolio. I don’t expect to make billions in my lifetime like he has. And all stocks carry risks as well as positive potential. Nevertheless, I do believe the strategy can help me succeed over time.
American Express is an advertising partner of The Ascent, a Motley Fool company. Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
