Source: Wikimedia Commons.
How do you pick a great stock?
As a financial writer, and one that focuses on stocks in particular, that’s a question that I think about a lot.
And each time I do so, I invariably come back to Warren Buffett, the chairman and CEO of Berkshire Hathaway Inc. (NYSE:BRK.A) and arguably the greatest investor of all time.
Unlike, say, a Peter Lynch, the former head of Fidelity’s famed Magellan Fund, which he ran from 1977 to 1990, Buffett has adroitly steered Berkshire Hathaway Inc. (NYSE:BRK.A) through every market cycle since the go-go years of the 1960s.
Under his stewardship, Berkshire Hathaway Inc. (NYSE:BRK.A)’s stock price notched a compound annual growth rate of 27.5% in the four decades between 1967 and 2007, handily beating the S&P 500 (INDEXSP:.INX) 19.8% performance.
How did he do it? His tactic was deceivingly simple.
The following table reveals Berkshire Hathaway Inc. (NYSE:BRK.A)’s five largest stock holdings. When it came to picking stocks, Buffett chose companies that had strong franchises and that, for one reason or another, were trading at a discount to their historical valuation.
| Company | Shares | Value | Percent of Portfolio |
|---|---|---|---|
| Wells Fargo & Co (NYSE:WFC) | 463,131,623 | $19,113,442 | 21.46% |
| The Coca-Cola Company (NYSE:KO) | 400,000,000 | $16,044,001 | 18.02% |
| IBM | 68,121,984 | $13,018,792 | 14.62% |
| American Express Company(NYSE:AXP) | 151,610,700 | $11,334,417 | 12.73% |
| Procter & Gamble | 52,793,078 | $4,064,539 | 4.56% |
Source: Insider Monkey.
He bought American Express Company (NYSE:AXP) in 1963 after one of its subsidiaries became embroiled in a fraud involving vegetable oil. But while the subsidiary ultimately declared bankruptcy, Buffett noted two things about its parent company. First, as described by the author Roger Lowenstein in Buffett: The Making of an American Capitalist, it wasn’t going down the tubes. And second, its name was one of the world’s greatest franchises.
A similar calculation underscored his decision to become The Coca-Cola Company (NYSE:KO)’s largest shareholder. As Lowenstein recounts,
The Coca-Cola Company (NYSE:KO) was the sort of “simple” business — one with pricing power and a protective “moat” — that Buffett came to crave, particularly in the 1970s. … [Its] main business was not selling The Coca-Cola Company (NYSE:KO); it was providing concentrate and syrup to bottlers and soda fountains. Such a business (unlike bottling) required little capital. What’s more, its name recognition was unique, especially overseas, where The Coca-Cola Company (NYSE:KO) outsold Pepsi four-to-one. In Buffett’s terms, the brand name was a sort of a universal toll bridge.
And the very same type of mindset led him to buy a 10% stake in Wells Fargo & Co (NYSE:WFC) in the midst of the savings-and-loan crisis. Because of fears of a downturn in the California real estate market, which Wells Fargo & Co (NYSE:WFC) had significant exposure to, Buffett was able to pick up $290 million worth of its stock for an average price of $58 per share — it had recently been trading for more than $80 a share.
The point is that while picking great stocks may not be easy — it takes an extraordinary amount of research and behavioral fortitude — it need not be complicated.
The article 5 Stocks Warren Buffett Loves originally appeared on Fool.com and is written by John Maxfield.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends American Express, Coca-Cola, Procter & Gamble, and Wells Fargo and (NYSE:WFC) owns shares of IBM and Wells Fargo.
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