Over the weekend, the annual shareholders’ letter of Berkshire Hathaway by its chairman, Warren Buffett, was released.
As usual, it contained insights that could be of interest to all share owners, not just those of Berkshire. Upfront, Buffett explained his approach to finding shares to buy – and it may sound surprising.
Stock picking
Buffett said that he and partner Charlie Munger are “not stock-pickers”, going so far as to emphasise “not” to make sure the point hit home with readers.
Yet Buffett is famous as one of the most successful investors in stock markets throughout history. So, if he is not a stock picker then what is he? In his words, “Charlie and I are not stock-pickers; we are business-pickers”.
The clue to what Buffett means by this is in what he writes before it. Buffett asked readers to “note particularly” that “we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves”. In other words, Buffett does not try to pick shares to buy now for his portfolio based on swings in the markets. Instead, he chooses businesses he wants to own a part of. He then buys shares in them if he thinks they are reasonably priced.
Applying the Warren Buffett method
Warren Buffett has billions of pounds he can use to buy whole companies. I cannot do that. But like Buffett, I can buy a piece of a company in the form of some shares.
He views shares as just that – a piece of a company. So he applies the same criteria when deciding whether to buy shares as he does when considering a whole company. Specifically, as the quotation above makes clear, he tries to figure out how a business is likely to perform over the long term. That is about the underlying value of a business, not its current share price. He then considers whether the price at which he can buy shares is attractive to him based on what he thinks are the long-term prospects for the business.
I can apply the same approach as Buffett when thinking about shares I might add to my portfolio. Instead of focussing on stock market moves, I would try to identify companies that have a specific driver for long-term business success. Then I would ask myself whether the company’s share price seemed like good value for me given what I felt the future prospects of the business to be. Note that I am not ignoring the share price – but it is not the leading motivation for me to invest in a company.
Learning from Buffett’s annual letter
The shareholders’ letter was the latest of many occasions on which Buffett has detailed how he chooses shares to buy for his portfolio. I find them to be a great source of inspiration, especially because Buffett explains why he invests the way he does. That makes it easier for a private investor like me to learn from a master – and apply the lessons to my own portfolio.
Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
