Warren Buffett's holding company Berkshire Hathaway (BRK.B) has been the single greatest investment of our lifetimes.
His compounded annual gain from 1966 to 2007 was 21.1% for an overall gain of 400,863%, compared to 10.3% and 6,840% for the S&P 500. However, Buffett experienced a rare earnings letdown during the second quarter of this year.
Although revenue increased 10% to $29.3 billion, insurance related write-downs hurt the company's bottom line. Still, the shortfall was far from cataclysmic. For the quarter, earnings fell 7.6% to $2.88 billion. Despite the shortfall, the company still maintains a top-notch credit rating and has over $28 billion in cash, a war chest for the world's greatest investor.
How has Warren Buffett's investment strategy been so successful? He takes a disciplined value approach to investing. And he sticks with it.
Warren Buffett's Investing Questions
Before Warren Buffett invests a dime, he asks:
- Is the company in an industry with good economics? That is, is it not in an industry competing on price?
- Does the company have a consumer monopoly or brand name that commands loyalty?
- Can anyone with an abundance of resources compete successfully with the company?
- Are the earnings on an upward trend with good and consistent profit margins?
- Is the debt-to-equity ratio low, or is the earnings-to-debt ratio high? Can the company repay debt even in years when earnings are lower than average?
- Does the company have high and consistent returns on invested capital?
- Does the company retain earnings for growth?
- Does the business have high maintenance cost of operations, high capital expenditure or investment cash outflow? (If so, that's not good.)
- Does the company reinvest earnings in good business opportunities? Does management have a good track record of profiting from these investments?
- Is the company free to adjust prices for inflation?
In short, he makes companies jump through a lot of hoops before he considers putting them in his portfolio.
Buffett's Investment Strategy - Concentrated Purchases
Buffett also makes concentrated purchases within his investment strategy. For its size, Buffett's portfolio has few stocks. But once a downturn comes, he buys millions of shares of solid businesses at reasonable prices.
Berkshire is a major player in the markets for insurance, soft drinks, chocolates, shoes, jewelry, publishing, furniture, steel, energy, homebuilding and private jets.
Berkshire owns significant portions in well-known, cheap, dividend paying stocks like:
- Coca-Cola (NYSE:KO)
- Wells Fargo (NYSE:WFC), one of the few U.S. banks in good standing.
- Procter & Gamble (NYSE:PG)
- Anheuser Busch (NYSE:BUD), which has seen a major boost in its share price thanks to the takeover bid from InBev.
- Conoco Phillips (NYSE:COP)
- Kraft Foods (NYSE:KFT) and others.
What is Warren Buffett Buying Now?
Besides buying large chunks of Swiss Re (SWCEY.PK), a major reinsurer, Buffett has been buying unloved - but sound - financial stocks.
He's increased his position in the Midwestern banking powerhouse U.S. Bancorp (NYSE: USB). (Documents show Berkshire is now the company's largest shareholder.)
Many household financial stocks have imploded in 2008. Bear Stearns and IndyMac, for example, are gone. Lehman Brothers is down 80% this year. Yet USB has held steady.
Buffett is also buying more Burlington Northern (NYSE: BNI), acquiring shares during the recent market weakness.
Warren Buffett's Investment Strategy & The Economic Downturn
Why is Buffett buying companies if, by his own admission, the economic downturn is likely to be deeper and longer lasting than generally expected?
- First off, because he knows that nobody can accurately or consistently predict something as big, diverse and dynamic as the global economy.
- Second, he knows that even if you somehow knew what was going to happen in the economy, you still wouldn't necessarily know what is about to happen in the stock market. Perversely, stocks sometimes fall during good times. They often rally during bad times.
- Third, Buffett knows that the stock market is a discounting mechanism. It takes the news and reflects it into stock prices immediately. Who in their right mind would sell their stocks today because he realizes the economy is slowing down? We've known that for months now.
Buffett knows that nothing beats the long-term returns available in equities. Where else can you put your money to work today? With real estate caught in a death spiral? In bonds that pay less than 5%? In money markets yielding 2%?
When we first recommended Berkshire Class B shares in February 2001, they were trading at $2,295. At the peak, shares traded as high as $5,059 in December 2007, a 123% return in a little more than seven years.
Yet the B shares are currently trading at $3,860, off 24% from the 52-week high and 20% year-to-date.
History shows that when Berkshire is down 24%, it's not just a good buy…
It's an outstanding one.