Billionaire investor Warren Buffett is a business picker and not a stock picker. He said that in his 2021 letter to the shareholders of Berkshire Hathaway — the company he uses as an investment vehicle.
The difference between the two terms emphasises his focus on high-quality enterprises. And it also underlines his mindset. Rather than approaching the market as a stock trader, he buys shares and then acts as if he owns the whole company. And that means he tends to hold on through thick and thin.
The reason for his long-term approach is that he wants businesses to grow their earnings while he’s holding the stock. And he wants companies to reinvest some of their profits back into operations to generate even more growth.
When businesses do that they are compounding their earnings. And usually that means Buffett’s returns from holding their shares compound as well. So Buffett doesn’t jump from stock to stock aiming to build on smaller gains. Instead, he holds stocks while the businesses themselves do the heavy lifting with regard to compounding.
Mr Wonderful
Buffett reckons most listed businesses are not worth buying because they are unlikely to deliver decent returns over time. However, there are a handful of enterprises with good quality indicators and realisable potential to grow their earnings. He calls the attractive ones “wonderful” businesses.
However, great businesses like that rarely sell cheaply. So Buffett aims to buy them when their valuations are “fair”. It was decades ago that he mostly stopped aiming to buy poor or mediocre businesses at bargain valuations.
But with his sights set on better quality outfits, the important thing is not to pay a valuation that’s too high. Paying too much can turn a long-term position in a wonderful company into a poor investment.
The basics
A focus on quality, earnings growth potential, valuation and a long-term mindset are the basics of the Buffett method. And he’s achieved compounded annual gains of 20.1% since the mid-1960s. I’d use the method as a basis for my own programme of regular investments, even if at the age of 45 or so without any meaningful savings.
It may not be possible to match Buffett’s performance. But even lesser annual gains may compound to a meaningful overall gain over time.
However, all stocks carry risks as well as positive potential. And that applies even if aiming to use the Buffett method. Nevertheless, my plan for building wealth from a standing start at 45 involves saving as much as possible every month. Then I’d invest into shares I’ve chosen carefully to hold for the long term, just like Buffett.
And I can’t remember a better time to begin investing in stocks and shares than right now. We’ve just endured a bear market for many shares and some valuations have been pummelled lower along with share prices. But many underlying businesses have been performing well. I reckon that combination of factors adds up to an opportunity.
