Legendary investor Warren Buffett is a source of inspiration for many share buyers because of his simple approach and superb track record. Based on Buffett’s approach, here are three things I look for when choosing shares to add to my portfolio.
1. Future, not past, performance
One surprising thing about Buffett is how much his investing has evolved over the course of decades. It’s easy to look at some of his holdings, such as insurance companies and Coca-Cola, and think that Buffett is investing for the world as it was in the 1950s, not now.
In fact, Buffett has moved on from declining industries many times. He loves newspapers but has largely abandoned the sector. Even the name of his company, Berkshire Hathaway, is a reminder of the textile business he spent decades trying to turn around before giving up. So, while Buffett may sound sentimental, in reality he adjusts his portfolio to reflect what he expects to happen in the future, not what he’s seen in the past.
That principle sounds simple to apply. But like many investors, I’ve held on to some shares too long because I focused too much on a company’s past successes when I should have been looking at its prospects.
2. Business models trump management
From Elon Musk at Tesla to Sir Martin Sorrell at S4 Capital, some companies definitely wouldn’t be where they are without a visionary leader at the helm. But Buffett reckons it’s a mistake to invest solely on the basis of a particular leader or management group. Instead, his approach is based on finding companies whose business models and market conditions give them a competitive advantage. Buffett calls that a “moat”. Like the waterways around castles, they help to keep potential opponents at bay.
Like anyone else, Buffett prefers a business to be run by diligent, talented management. But that’s essentially a bonus. What he’s looking for are businesses whose success comes from their moat more than management. A UK example I would consider buying is National Grid. Its installed network gives it a competitive advantage that a competitor would find it expensive or impossible to replicate. One risk with shares with a strong moat, like National Grid, is that they can be popular with investors, meaning their shares trade at expensive valuations. And regulatory changes can reduce their profitability at a stroke in some cases.
3. Warren Buffett waits
One of the biggest mistakes many investors make is being impatient.
Buffett is happy to do nothing for years on end and wait for the small number of great opportunities he thinks come most people’s way in a lifetime. It can be tempting to jump in and out of markets, so I find his approach here instructive.
He suggests imagining that one could only take 20 investing decisions in a lifetime. His litmus test for any share purchase or sale would be whether it was sufficiently attractive to justify using one of those 20 opportunities. I find that mental model focuses my mind as an investor on the hunt for exceptionally good investment ideas.
