Buffett's philosophy on business investing is a modification of the value investing approach of his mentor Benjamin Graham. Graham bought companies because they were cheap compared to their intrinsic value. He was of the belief that as long as the market undervalued them relative to their intrinsic value he was making a solid investment. He reasoned that the market will eventually realize it has undervalued the company and will correct its course regardless of what type of business the company was in. In addition he believed that the business has to have solid economics behind it. Buffett's investment style is also heavily influenced by Phil Fisher.
The following are some questions to determine what business to buy, based on the book Buffettology by Mary Buffett:
- Is the company in an industry with good economics, i.e., not an industry competing on price. Does the company have a consumer monopoly or brand name that commands loyalty? Can any company with an abundance of resources compete successfully with the company?
- Are the Owner Earnings on an upward trend with good and consistent margins?
- Is the debt-to-equity ratio low or is the earnings-to-debt ratio high, i.e. 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?
- The business should not have high maintenance cost of operations, high capital expenditure or investment cash outflow. This is not the same as investing to expand capacity.
- 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?
Buffett also concentrates when to buy. He does not want to invest in businesses with indiscernible value. He will wait for market corrections or downturns to buy solid businesses at reasonable prices, since stock market downturns present buying opportunities.
He is known for being conservative when speculation is rampant in the market and being aggressive when others are fearing for their capital. This contrarian strategy is what led Buffett's company through the Internet boom and bust without significant damage, although critics have also noted that it may have led Berkshire to miss out on potential opportunities during the same period.
He also asks at what price is the business a bargain, and his answer typically is when it provides a higher rate of compounded return relative to other available investment opportunities.
Warren Buffett's letters to shareholders are a valuable source in understanding his investment style and outlook.[13]
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