How to invest like Warren Buffett

The Oracle of Omaha isn’t the world’s third richest man for nothing. How does he do it?

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Undoubtedly, Warren Buffett is one of the greatest investors of all time. It’s impossible to argue with the returns of his Berkshire Hathaway — a 19.8% average annual increase in book value that spans back to the the times of LBJ. During this time, the S&P 500 averaged less than half that average annual return.

Buffett exemplifies a disciplined investing approach from which we can all take notes. Let’s see what the Oracle of Omaha craves when combing through the stock universe, and how his top holdings fit these criteria.

Top stock holdings
Over the past several years, Buffett has invested substantially in the following companies. Berkshire Hathaway owns anywhere from 4.5% to 13% of the companies listed below.

Company

Share Price

Cash per Share

Long-Term Debt to Equity vs. Industry Average

ROE

American Express (NYSE: AXP) $57.57 $23.16 3.17 vs. 5.17 26.6%
Coca-Cola (NYSE: KO) $74.20 $6.99 0.43 vs. 0.62 26.7%
International Business Machines (NYSE: IBM) $201.57 $10.73 1.14 vs. 0.62 73.7%
Kraft Foods (NYSE: KFT) $38.35 $1.17 0.66 vs. 0.69 9.9%
Wells Fargo (NYSE: WFC) $33.06 $31.47 0.97 vs. 1.69 11.9%

All $ amounts in US$. Sources: Yahoo! Finance, The Motley Fool.

Simple business
Buffett loves a simple business that doesn’t require a Ph.D. to understand. Coca-Cola and Kraft operate straightforward businesses; they make sugary water and snacks. We consume their products on a daily basis, and we easily understand these businesses. Wells Fargo, not so much. But of the big bank stocks, Wells has daintily tiptoed into speculative waters in comparison to its cannonballing peers.

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Sound management
Company executives and CEOs who focus on allocating capital and rewarding shareholders are favourites of Buffett. Buffett is on record heaping praise on his favourite managers and those who have done a good job. I imagine the silence feels聽deafening聽for those who rarely rate a mention.

Healthy balance sheet
Buffett likes lots of cash and little or no debt on the books. Companies not saddled with debt more easily make acquisitions or buy back shares.

I took a look at the total cash per share for each of the five companies. Wells Fargo has a ton of cash, as does American Express, although balance-sheet cash for financial companies plays a different role than cash at most companies. Not surprisingly, the more capital-intensive businesses and those that have made recent acquisitions using cash possess less of it. Those companies include Coca-Cola, IBM, and Kraft.

All of the companies except for IBM possess less long-term debt-to-equity than their respective industry peers, solidifying strong positions within their industries for making acquisitions, increasing dividend payouts, or buying back shares.

Solid returns on equity
Buffett looks for companies that produce stellar returns on their investments. Return on equity is the amount of net income returned as a percentage of shareholder equity; it’s a measure of profitability. Nearly all five companies possess double-digit returns on equity. IBM posts a whopping 73%, while American Express and Coca-Cola each display very strong ROEs of nearly 27%.

Share repurchases at the right time
Buffett applauds a company that repurchases shares when its stock is “selling at a discount to its intrinsic business value.” These companies not only identify but take advantage of when their stocks are trading cheap.

All five companies bought back shares in the fourth quarter of 2011. Most notably, Wells Fargo bought back about 26.5 million shares at an average price of US$26.45; today the stock trades at US$32.53, representing an 18% profit on what Wells paid.

Also, American Express bought back more than 7 million shares in the fourth quarter of 2011 at an average price per share of US$49.64. The stock trades just under US$57 today, giving the company a 13% return on its buybacks.

Warren-worthy
If these shares entice Buffett, they’re surely good enough for you and me to consider. But do some Foolish research of your own, and see if these, or other companies are a good place for your money.

You’ve seen how Warren Buffett invests, and even some examples of the companies he holds. Check out our new report,聽2 ASX Stocks Warren Buffett Wishes He Could Buy聽for a couple of ASX businesses we think might catch the eye of the Oracle of Omaha — at least one of which we think will surprise you. Click here now to request your free copy, before it’s too late.

Take Stock聽is The Motley Fool Australia鈥檚聽free聽investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.聽Click here now聽to request聽your free subscription, whilst it鈥檚 still available.聽This article contains general investment advice only (under AFSL 400691).

A version of this article, written by Nicole Seghetti, originally appeared on fool.com

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