The success of Warren Buffet

Warren Buffet, I believe, is one of the most successful investors of modern times. What is his secret for choosing what companies to invest in?

Incredibly, a $10,000 investment in Berkshire Hathaway in 1965, when Warren Buffett took control of the company, grew to be worth over $50 million by 2003. By comparison, the same $10,000 invested in the S&P 500 index would have grown to 'only' $500,000.

Whether you like him or not, Buffett's investment strategy, known as value investing, has been one of the most successful investment stories ever. So what is Warren Buffett's investing philosophy?

Value investing looks for stocks whose prices are low for their companies' supposed intrinsic worth, which is determined by an analysis of certain characteristics and fundamentals of companies. Mirroring the mentality and shopping style of a bargain hunter, value investors look for products that are beneficial and high quality but cheap in price.

In other words, the value investor searches for stocks that he or she believes are undervalued by the market. Like the bargain hunter, the value investor tries to find those items that are valuable but not quite recognised as such by the majority of other buyers.

Buffett takes this value investing approach to another level. Many value investors aren't supporters of the Efficient Market Hypothesis but trust that the market will eventually properly start to favour those quality stocks that were, for a time, undervalued.

Buffett, however, doesn't think in these terms. He isn't concerned with the supply and demand of the stock. In fact, he is not really concerned with the activities of the stock market at all. He chooses stocks solely on the basis of their overall potential as companies and he looks at each company as a whole.

By holding these stocks for the extended long term, Buffett seeks not capital gain but ownership in quality companies that are highly capable of generating earnings. When Buffett invests in a company, he is not concerned whether the market will eventually recognise the company's worth; he is concerned with how well that company can make money as a business.

Some of the questions Buffett asks himself when he evaluates the relationship between a stock's level of excellence and its price include (bear in mind that these are not the only things that he analyses):

a) has the company consistently performed well?

b) has the company avoided excess debt?

c) are profit margins high and are they increasing?

d) how long has the company been public?

e) is the stock selling at a 25% discount to its real value?

As you can see, Buffett's investing style, like the shopping style of the bargain hunter, reflects a practical, down-to-earth attitude. He maintains this attitude also towards his lifestyle and overall philosophy on life, i.e. he doesn't live in a huge house, he doesn't collect cars, and he doesn't take a limousine to work.

Although the value-investing style is not without its critics and, whether you support Buffett or not, the proof is in the pudding. As of 2003, he holds the title of the second richest man in the world, with a net worth of over $30 billion (source: Forbes 2003).

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 (office hours) or e-mail mh@hollingsworth-int.com.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.