The "Sage of Omaha" is one of the richest men in the world but behind Warren Buffett's investments lies a fundamental, relatively straight-forward set of principles.
Buffett buys in companies where he sees long-term success. As the man himself stated, "I look for businesses in which I think I can predict what they're going to look like in 10 to 15 years' time." This approach is at the heart of every investment decision made by Buffett.
In an interview with Investor's Chronicle, according to Mary Buffett, Warren's ex-daughter-in-law, this long-term approach is based on three points:
1) The product or service offered by the company must stay constant for the next 10 to 15 years. This way he can predict with more reliability how the company may perform. Take Buffett's recent investment in Tesco (OTCPK:TSCDY) to add to his investment in the supermarket industry, already owning shares in Wal-Mart (NYSE:WMT). Tesco is the third-largest supermarket chain in the world after Wal-Mart and Carrefour (OTCPK:CRRFY). As they are two of the most profitable supermarket groups in the world, it is likely that they will continue to be dominant and profitable over the next decade or more. Indeed, despite losses incurred by Tesco's Fresh and Easy store chain, Buffett has not seen this as a huge problem, further increasing his stake in the company. The same logic applied to these supermarket chains can be applied to other shares held by Buffett such as Coca-Cola (NYSE:KO) or Johnson and Johnson (NYSE:JNJ), which have been consistently profitable for decades and continue to perform well. Predictably well.
This may be why Buffett steers clear of industries such as technology as fierce competition and constant need to update products can lead to volatile stock performance and unpredictable turns of events. Nokia for example was once a market leader in mobile phones. Not only that but predicting how Apple (NASDAQ:AAPL) or Research in Motion (RIMM) will be performing in 10 years is much more difficult than predicting how Coca-Cola will be doing.
2) Buffett invests in industries he understands fully. Supermarkets (TSCDY.PK, WMT) and food companies such as Kraft (KFT) do not represent industries that may be more complicated to understand, as Mary Buffett has pointed out. Their products are straight forward and thus it is easier to see how they may perform in the future.
3) The "Sage of Omaha" identifies companies holding a monopoly in their sector or that hold a competitive advantage by offering something competitors don't on similar products or being identified with low-cost, good value. The predictability of the product equates to predictable profits, according to Mary Buffett. In particular this would be represented by household brand names. If you are in a restaurant and the house serves its own brand of cola, most people would still refer to it as a Coke.
After considering the above points, Buffett then assesses the price of a stock and whether it represents value. He often watches stocks he is interested in and pounces if they fall in price. He did this very recently with Tesco, adding to his shares when Tesco's stock price fell by 20% at one point in January of this year. Buffett tends to invest in companies that are household names (Coca-Cola) or those that offer everyday use or necessities (Johnson and Johnson, Tesco or American Express (NYSE:AXP)). JNJ in particular supplies scores of everyday products, which leads to consistent, predictable revenue. These kinds of companies will inevitably benefit from the ever-increasing global population size increases as more people equates to more demand for necessary products and thus increasing profit margins. The United States alone is projected to swell to 438 million people by 2050, from current levels of just over 300 million. This is an important point that should not be overlooked.
Before investing a company must represent good value through stock price and if it is likely to produce consistent long-term profits. Buffett continues to use the above process as a guide to investing. It has laid the foundation for his unparalleled success and if an investor wishes to learn from Buffett, he or she may wish to consider adopting this set of principles when analyzing stocks for investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.