Direct Share Investing - Warren Buffet Investment Method

Updated: Returns are now for the period ending 31 December 2011

For direct share investing, I use an investment method similar to that used by Warren Buffet.

For the first step, I use a software program that scans the entire market, to find the small number of companies that meet my stringent "Warren Buffett" criteria. The criteria I use includes: debt to equity, current ratio, quick ratio, interest cover, stability of earnings, stability of sales, return on equity, return on capital, at least a 4 year performance track record, a market capitalisation threshold and a margin of safety (or worst case scenario). The second step is to sort these companies from highest to lowest estimated return. The third and final step is to perform detailed analysis on the companies that passed through the first scan.

So who is Warren Buffet?

He is one of the most successful investors in the world. He is the Chairman and CEO of Berkshire Hathaway, a diversified investment company valued at over US$191 billion (as at January 2011). Before that Buffett ran private investment partnerships.

Suppose someone had the good sense to invest US$10,000 in one of Buffett's original partnerships back in 1956 when they first started. And suppose that when the partnerships terminated in 1969, that person reinvested the proceeds in Berkshire Hathaway. Today that person would be worth over US$280 million - after all taxes and expenses.

To understand the Warren Buffett Investment Method, we need to recognise that he does not think about the stockmarket. "We look at individual businesses," he once said. "And we don't think of stocks as little items that wiggle around in the paper. We think of them as parts of businesses."

One of the best quotes that describes the Warren Buffett Investment Method is the following: 

"Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher 5, 10 and 20 years from now."

Suppose we used the Warren Buffet Investment Method to invest in Australian companies between Jan 2001 and Dec 2011. The income and growth returns* using this method are shown below as the CMP Portfolio and are compared to the returns from the All Ordinaries index.

Chart 1 - Calender Year Returns 

Chart 2 - Performance Over 11 Years - Starting With $100,000

* Past performance is not indicative of future performance. The future value of investments may rise and fall with changes in the market. I have assumed 3% annual dividends with 60% franking.

The total returns above show there is a strong case for using the Warren Buffet Investment Method to invest in Australian companies.

 
To learn more about direct share investing and the Warren Buffet Investment Method for your investment portfolio or self managed super fund, call 9372 7955.

Important Information

The above information provides an overview or summary only and it shouldn’t be considered a comprehensive statement on any matter or relied upon as such. The above information doesn’t take into account your personal objectives, financial situation or needs. It’s important for you to consider these matters before making any financial decision and I recommend you seek help from a financial adviser.