The secret to Buffett’s success?

A group of researchers believe they have cracked Buffett’s code!

A recently published academic paper titled Buffett’s Alpha by Frazzini, Kabiller and Pedersen claims to discovered new insights into famed investor and billionaire Warren Buffett’s investment style. Unlike much of the published analysis and commentary about Buffett, which is primarily qualitative in its appraisal, Frazzini, Kabiller and Pedersen “seek the answer via a thorough empirical analysis in light of some of the latest research on drivers of returns.”

The findings

The authors focussed on Buffett’s record at Berkshire Hathaway (NYSE: BRK.A) from 1976 and found that: “Buffett’s returns can largely be explained by the use of leverage combined with a focus on cheap, safe, quality stocks.”

Turning first to the finding regarding the use of leverage, the study estimates that on average Berkshire Hathaway has had leverage of roughly 1.6:1. This would suggest that the GEICO Insurance purchase was really one of the most important purchases Buffett ever made. This purchase alone gave Buffett access to literally “free” money in the form of insurance float – a primary source of the leverage described.

Secondly, the study found that buying cheap, safe, quality stocks is a key to his success. It’s worth repeating the authors’ definition of safe – stocks with low beta and low volatility — and cheap – value stocks with low price-to-book ratios and high quality, meaning stocks that are profitable, stable, growing, and with high payout ratios.

It is also worth noting that the study determined that Buffett’s ability to buy a bargain through publicly traded stocks versus private companies was an important contributor to his outperformance and where Buffett’s major advantage lies.

Will there be another Buffett?

That is of course a hard question to answer, however given human nature to keep evolving, expanding and learning it’s certainly quite possible. An obvious place to look for the next Buffett of Berkshire Hathaway is companies that are structured in a similar way.

Comparing any investor or company to Buffett is fraught with danger, however there are a few companies that offer ‘glimmers’ of a Berkshire Hathaway. Wesfarmers (ASX: WES) has a conglomerate structure and an enterprising nature that allows it to invest wherever it sees an opportunity. It also has an insurance division that is expanding and could potentially give it a GEICO-like attribute.

There are also investors who share a similar philosophy and approach to investing as Buffett. Hamish Douglas at Magellan Financial Group (ASX: MFG) is one investor who stands out. Douglas’ track record is of course much shorter that Buffett’s; however since the inception in 2007 of Magellan’s flagship fund, Magellan Global, the fund has achieved returns of 9.64% per annum, an outperformance against its benchmark of 9.62% per annum.

Foolish takeaway

Having attributes similar to Buffett or Berkshire certainly doesn’t mean the same outstanding returns can be achieved. As the study points out there are a number of unique aspects to the Buffett-Berkshire set-up which have all played their part in achieving the exceptional returns.

Berkshire Hathaway doesn’t pay a dividend but Buffett likes to buy companies that do! Interested in our #1 dividend-paying stock? Discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”

More reading


Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

Wondering where you should invest $1,000 right now?

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for over ten years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of January 12th 2022

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

asx share price competitions represented by businessmen arm wrestling
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

person reading news on mobile phone
⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »