This is how Warren Buffett’s share selection process works
The first stage of Buffett’s strategy is checking if the company has a durable competitive advantage.
Let me show you what I mean…
Stage 1: Does the share have a durable competitive advantage?
Warren Buffett’s Patient Investor strategy looks at certain figures and ratios to check if a company has a durable competitive advantage.
The first, and most important, is earnings predictability. It’s a major indicator of a durable, competitive business. This strategy like companies that have solid, stable earnings which are continually expanding.
If a company doesn’t have predictable earnings, Buffett wouldn’t give the stock a second look. This is because predictable earnings allow Buffett to accurately predict future earnings.
Next, the strategy looks at the following criteria to check just how well the company has been performing. A solid stable performance indicates a company has a durable competitive advantage.
Here’s what it looks at:
i) Companies should have a consistently higher than average Return on Equity (ROE) of at least 15%.
If a company meets this criteria it shows it consistently rewards investors and should continue to do so.
ii) A share must have consistently higher than average Return on Assets (ROA) of at least 1%.
This basically shows how many rands of earnings result from each rand of assets the company controls… And it gives an idea of how efficient management is at using its assets to generate profits.
So by having this requirement we can be sure we have the right managers behind the reins.
iii) Management uses retained earnings in a way that benefits shareholders.
To calculate this for a company, Buffett takes the total amount of retained earnings over the previous ten years and compares it to the gain in earnings per share (EPS) over the same period.
If this is high at about 15%, it’s more than acceptable and shows management is doing a great job putting the company’s extra money to work.
iv) Companies shouldn’t have major capital expenditure in order to keep it competitive.
This strategy likes companies that don’t have major capital expenditures. In other words, it looks for companies that don’t need to spend a ton of money on major upgrades of plant and equipment, or on research and development to stay competitive.
Now, don’t stress if this all seems like a lot of work. You can sit back and let me do all the work for you.
Because in the Unconventional Millionaire
I make use of this strategy, as well as eleven other investment guru strategies to select market-beating stocks!
Thrive in your possibilities,