How can investors try to emulate Warren Buffett’s approach?

Warren Buffett is 93 so there may be limited further opportunities to tap into the wit and wisdom of the world’s most successful investor. That’s why I’ll be watching out for Berkshire Hathaway’s third quarter results this week. Buffett has been at the helm of what’s become a US$700bn conglomerate since he assumed control of a failing New England textile mill in 1965.

Along the way, he has been at times the richest person in the world and always an inspiration to generations of investors thanks to his pithy insights, honesty and charm.

Two things, in particular, are worth keeping an eye on in the upcoming report. The first is what’s happened to Berkshire’s towering cash pile. At the end of June, the company was sitting on a colossal US$147.4bn. Not that this mountain of uninvested cash has prevented Berkshire from delivering excellent returns to shareholders. The company’s shares have outperformed the broader US market over pretty much any period you care to look at. Over the past year it has done twice as well as the S&P 500. Over 20 years, the value of Berkshire has grown seven-fold, easily outstripping the quadrupling of the US benchmark.

The second thing I’ll be interested in is what Buffett has to say about the company that now accounts for nearly half the value of Berkshire’s equity holdings. Buffett bought Apple (NASDAQ: AAPL) shares in the first quarter of 2016, and they have turned out to be one of his best investments, rising in value by more than 500pc since he started to build a stake of nearly 6pc in the world’s biggest business.

Buffett was late to the tech party, but it is no surprise that he alighted on Apple seven years ago. It ticks all his stock selection criteria - a high quality business, with a captive market, excellent management and a massive defensive ‘moat’ that prevents competitors attacking its dominant position. In some ways it is surprising that it took Buffett so long to arrive at Apple. It always had a strong brand and incredible customer loyalty, but it was the growth of the company’s services arm that marked the transition from a classy hardware manufacturer to a brand that people cannot imagine living without. That was Buffett’s great insight, and the surge in Apple’s value since 2016 has been his reward.

Three years ago, in an interview with Yahoo, Buffett said of Apple: 

‘I just think of the utility of those products to an ecosystem that is demographically terrific and finds that instrument useful dozens and dozens of times a day. It’s almost indispensable, not only to individuals, business, I mean, everything.’

This is classic Buffett. It’s not the glitzy tech that interests him but the fact that we can’t do without our phones. That we are addicted to them. Way back in the 1980s he said, unfashionably from a modern perspective, that he loved the cigarette business because: ‘it costs a penny to make. Sell it for a dollar. It’s addictive. And there’s fantastic brand loyalty.’

No wonder he likes Apple today.

Some of Buffett’s most successful investments have shared this ageless, must-have characteristic. Take Gillette, in which Buffett took a stake in 1989. As with Apple, Buffett was not exactly early to the party. People had been using Gillette products for years. In fact, at the time of the initial purchase, it looked to be in trouble. Disposable razors had been taking share from the company throughout the 1980s and it had narrowly fended off a hostile takeover. Buffett saw his opportunity, acquiring 11pc of the company for US$600m, which bought him a seat on the board and a US$52.5m annual dividend. By the time Procter & Gamble bought the company in 2005, it was worth US$5bn.

Buffett’s investment in Gillette followed a tried and tested template. In 1972 he had bought See’s Candies for US$25m. Another simple business, a chain of old-style sweet shops, ticked all Buffett’s criteria. It was highly profitable, with a 60pc return on invested capital. It was a cash business, with minimal inventories. Price was not a big issue for the purchasers of its products - they could be pushed up before Valentine’s Day each year, no-one seemed to care and the extra revenue just went straight through to the bottom line. In many ways, the perfect business model.

But Buffett does not just buy great businesses. He also waits for what they call in baseball the ‘fat pitch’, the moment when a purchase really is a no brainer because Mr Market is temporarily giving something away for free. Buffett’s investment in Coca Cola shortly after the 1987 stock market crash, is the classic example. Again, it is an unmatched brand, sold in 200 countries around the world and instantly recognisable. Buffett bought a 6pc stake for US$1bn in 1988. It now owns 9pc, worth US$23bn. The purchase of Apple was another marvel of market timing. In 2016, Apple was valued at around 11 times its earnings. Today, its shares trade on closer to 30 times profits.

So, how can investors try to emulate Buffett’s approach? First, they need to do the hard work. Buffett never invests on a whim. He is not interested in short-term fads. He studies the numbers, looking for a long-run track record of high and sustainable returns on equity, high margins and strong balance sheets with little debt. He looks for unique products that we cannot or do not wish to do without. He insists on strong and honest management. He bides his time and waits for the market to offer these rare businesses at an attractive price.

As Apple, See’s, Gillette and Coca Cola have shown, you don’t have to do that many times in an investing career. But you do have to be patient. They don’t come along very often. And nor do investors like Buffett.

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All prices and analysis at 6 November 2023.  This document was originally published on Livewire Markets website on 6 November 2023. This information has been prepared by Fidelity International (Australia) Limited ABN 33 148 059 009 AFSL No. 409340.

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