What Makes an Attractive Warren Buffett Stock?

•
An
economic
moat
•
An
outstanding
management
team
•
Thoughtful
capital
allocation
•
Actual
earnings
power
and
financial
strength
•
An
easy-to-understand
business

Here,
I’ll
dig
into
some
of
the
key
traits
Buffett
has
focused
on
since
he
started
his
investment
career
nearly
seven
decades
ago.

Trait
1:
An
Economic
Moat

Above
all
else,
Buffett
looks
for
companies
with
a
durable
competitive
advantage,
or
economic
moat.
Just
as
a
circle
of
water
or
dry
land
protects
a
castle
from
intrusion,
an
economic
moat
protects
a
company
from
being
encroached
on
by
competitors.
In
his
extensive letters
to
shareholders over
the
years,
Buffett
has
discussed
several
key
moat
sources,
including
a
low
cost
of
production,
economies
of
scale,
unique
products
that
competitors
can’t
replicate,
exceptional
distribution
systems,
and
a
strong
brand
identity.

Examples
from
Berkshire
Hathaway’s
investments:

•

Geico
A
Berkshire
subsidiary
that
has
enjoyed
a
durable
cost
advantage
by
selling
policies
directly
instead
of
paying
sales
reps.

•

Coca-Cola (KO)
It
has
profited
from
a
strong
brand,
an
extensive
distribution
network,
and
millions
of
customers
who
won’t
switch
to
another
beverage.

•

Apple (AAPL)

It
boasts
a
carefully
maintained
ecosystem,
favourable
demographic
trends,
and
indispensable
products.

Trait
2:
An
Outstanding
Management
Team

Buffett
also
seeks
out
companies
with
outstanding
CEOs.
Some
of
the
qualities
he
looks
for
are
integrity,
financial
discipline,
dedication
to
quality,
maintaining
a
tight
focus
on
their
circle
of
competence,
and
thinking
independently
instead
of
falling
victim
to
the
“institutional
imperative,”
which
involves
resistance
to
change,
making
misguided
acquisitions,
catering
to
the
business
leader’s
whims,
and
mindlessly
imitating
the
strategy
of
other
companies
in
their
peer
group.

Examples
from
Berkshire
Hathaway’s
investments:

•

Katherine
Graham
and
Dick
Simmons
from
the
Washington
Post
Company,
now
Graham
Holdings (GHC)
Buffett
praised
the
late
duo
for
their
managerial
skills,
integrity,
and
dedication
to
treating
shareholders
well.

•

Capital
Cities/ABC’s
late
executives
Tom
Murphy
and
Dan
Burke
Buffett
called
them
the
“best
managerial
duo”
that
he
had
ever
seen
thanks
to
their
ability,
integrity,
and
skill
at
both
operations
and
acquisitions.

•

Coca-Cola’s
late
chairman
and
COO Donald
Keogh

Buffett
praised
him
for
his
business
talent
and
ability
to
bring
out
the
best
in
people
around
him.

Trait
3:
Thoughtful
Capital
Allocation

This
trait
is
closely
related
to
the
previous
one.
Buffett
looks
for
companies
with
boards
and
management
teams
that
consistently
deploy
their
capital
to
build
shareholder
value
over
time.
He
avoids
companies
with
executives
who
are
prone
to
distractions, empire-building,
frittering
away
money
on
acquisitions,
and
diluting
shareholder
value
by
issuing
shares.

This
line
of
thinking
has
heavily
influenced
how
Berkshire
Hathaway
itself
is
managed.
Buffett
wrote
somewhat
sheepishly
about
the
company’s
1986
purchase
of
a
corporate
jet
(nicknamed
The
Indefensible)
but
ultimately
came
to
appreciate
that
it
made
travel
significantly
more
comfortable
and
efficient.
He
has
also
frequently
written
about
Berkshire’s
streamlined
corporate
staff
and
the
value
of
share
repurchases,
which
are
a
tax-efficient
way
to
give
each
shareholder
a
larger
stake
in
the
company.

Examples
from
Berkshire
Hathaway’s
investments:

•

Coca-Cola
The
company
has
bought
back
3.6
billion
shares
of
common
stock
(as
of
Dec.
31,
2023)
at
an
average
price
of
$17.96
since
it
first
introduced
its
share
repurchase
program
in
1984.

•

The
Washington
Post
Company

Buffett
praised
it
for
making
share
repurchases
at
low
prices.

•

Capital
Cities/ABC
(now
part
of
Walt
Disney (DIS))

Buffett
admired
it
for
its
thoughtful
and
effective
acquisition
strategy.

•

Apple

The
company
has
repurchased
roughly
$600
billion
worth
of
its
own
shares
over
the
past
10
years.

Trait
4:
Actual
Earnings
Power
and
Financial
Strength

Buffett
has
often
written
about
the
limitations
of
audited
financial
statements.
One
particularly
good
Warren
Buffet
quote:
“It’s
simply
to
say
that
managers
and
investors
alike
must
understand
that
accounting
numbers
are
the
beginning,
not
the
end,
of
business
valuation.”

He
made
a
sharper
critique
in
his 2023
letter
to
shareholders,
deriding
reported
net
income
figures
as
“worse
than
useless”.

There
are
two
main
reasons
for
his
scepticism
about
publicly
reported
financial
results.
First,
they
provide
only
a
snapshot
(either
annual
or
quarterly)
of
a
company’s
results.
Second,
accounting
earnings
can
frequently
be
distorted
by
unrealised
capital
gains
and
losses,
mergers
and
acquisitions,
tax
quirks,
and
other
issues.

To
avoid
these
problems,
Buffett
instead
focuses
on
companies
with
underlying
earnings
power
and
financial
strength.
His
preferred
measure
is
operating
earnings,
which
strips
out
items
such
as
noncash
inventory
costs,
depreciation,
goodwill
amortisation,
and
deferred
taxes.
He
also
uses
other
metrics
such
as
return
on
equity
capital
and
free
cash
flow.

Examples
from
Berkshire
Hathaway’s
investments:

•

The
Washington
Post
Company

It
has
benefited
from
a
subscription
business
model
and
low
debt.

•

Geico
Has
a
rock-bottom
cost
structure
and
enjoys
the
benefits
of
float,
which
is
the
money
an
insurance
company
receives
upfront
and
can
invest
until
claims
are
paid
out.

•

Burlington
Northern
Santa
Fe
It
requires
heavy
capital
investments
but
provides
a
fundamental
service
that’s
essential
to
people
and
businesses
around
the
country.

•

See’s
Candies

It
has
a
low
cost
structure
and
millions
of
repeat
customers
for
its
boxed
chocolates.

•

MidAmerican
Energy

An
electric
utility
that
operates
in
Iowa,
Illinois,
Nebraska,
and
South
Dakota.
While
the
utilities
business
is
heavily
regulated
and
capital-intensive,
it
can
generate
attractive
profits
over
time.

Trait
5:
An
Easy-to-Understand
Business

This
trait
is
a
close
cousin
to
the
previous
one.
Buffett
values
simple,
easy-to-understand
business
models
and
shuns
complexity.
For
this
reason,
he
avoided
technology
stocks
for
many
years
(although
he
eventually
bought
shares
in
IBM
in
2011
and
Apple
starting
in
2016).
He
has
also
generally
shunned
other
rapidly
evolving
industries,
such
as
airlines,
paper,
and
investment
banking.

Examples
from
Berkshire
Hathaway’s
investments:

•

Gillette,
now
part
of
Procter
&
Gamble
(PG)
A
business
that
Buffett
described
as
“very
much
the
kind
we
like”.
It
has
a
standardised
product
that
needs
to
be
replaced
often,
leading
to
brand
loyalty
and
repeat
purchases.

•

See’s
Candies

It
has
a
similarly
uncomplicated
business
of
making
candy
(mainly
chocolate)
and
selling
it.

•

Nebraska
Furniture
Mart
It
was
founded
by
Rose
Blumkin,
a
Russian
immigrant,
in
1937.
Blumkin
(officially
known
as
Mrs.
B)
described
her
company’s
business
model
as
“sell
cheap
and
tell
the
truth”.

Simple,
But
Not
Easy

The
five
traits
I
described
above
aren’t
rocket
science,
but
they
may
be
deceptively
straightforward.
Buffett
himself
has
described
investing
as
“simple,
but
not
easy.”
It’s
highly
unlikely
that
any
individual—or
professional—investor
would
be
able
to
replicate
Berkshire
Hathaway’s
record
by
applying
these
precepts.
Indeed,
Buffett
has
advocated
broadly
diversified index
funds with
low
fees
as
the
best
choice
for
most
investors.
For
those
willing
to
take
on
the
risk
of
individual
stocks,
though,
focusing
on
the
five
qualities
above
is
an
excellent
starting
point.

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