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Study on Warren Buffett investment strategy and 5 stocks to invest

From a beginner investor to an expert investor, everyone dreams of mirroring the path of legendary investor Warren Investor and become arguably the best investor in the world. 

Below in the article, I have listed 5 of the top stock picks for starting a Warren Buffett style investment portfolio. These 5 stocks have been picked from the famous book Buffettology. I reckon Buffettology is a must-read for every investor.

Before I conduct a detailed assessment of the stocks let us take a deeper look into the investment history and strategy of Berkshire Hathaway.  

Similar to any successful entrepreneur or stock market investor, Berkshire Hathaway has multiple sources of income. It boasts of a portfolio of nearly 61 operating companies that generate income through sales and profit.

Founded back in 1955, currently, Berkshire Hathaway is a $100 billion company, this capital keeps on getting invested in productive assets or several ventures and multiplies over time.

The Warren Buffett operated company boasts of a stock portfolio which includes shares of billion-dollar companies like Apple Inc. and Coca-Cola as well as of various American banks.

I am sure each and every investor tracks the movements made by Warren Buffett’s Berkshire Hathaway particularly the stocks which are bought and sold by the company.

Buffett’s market sentiments, his opinions on undervalued companies or unorthodox companies and the companies with an unbeatable competitive position are reflected by Berkshire’s moves in the stock market.

If you compare Berkshire Hathaway’s portfolio compares to the market in general, in comparison to a 9.7% return for the S&P 500 Berkshire’s A-shares have compounded a 20.6% return from 1965 till the end of 2018. 

As per an analysis of the portfolio conducted by principals at AQR Capital Management who wanted to study the “Buffett Alpha”,  they found out that in comparison to any stock that has traded for 40 years going back to 1926, Berkshire has the highest Sharpe ratio (a measure of risk-adjusted performance), the study was published by the Financial Times.

This report suggests that Berkshire is the topmost mutual fund amongst all others since 1976.

If we compare the S&P 500 and Berkshire, the latter’s portfolio is highly concentrated around a small number of stocks. 

Apple makes up 22% of Berkshire’s holdings, and the top five positions are 62% of the $100 billion portfolios. For the S&P 500, the top holding is just 3.7% of the index, and the top five stocks make up 13.5% which shows that it is comparatively less concentrated.

High concentration in financial stocks is another unique feature of Warren as he holds about $60 billion worth of large and regional banks or roughly 31% of Berkshire’s public stock exposure.

In recent times, financial stocks have taken a few hits however, it has managed to be aligned with the overall market looking at the five-year performance, as shown by the Financial Select Sector SPDR ETF (XLF).

It is no secret that if you wish to beat the market you will need a unique and unorthodox approach. Holding stocks that have a different weighting than index or holding stock that is not in the index is one such unique approach. The term “active share” is a definition of how different a portfolio is in comparison to its comparable benchmark.

Portfolio managers with over 80 percent are said to have a “high” active share. And portfolio managers who own high active shares are known to outperform the market.

Berkshire’s active share increases on the disparity in Berkshire’s stakes of Apple (22%) and the S&P 500 (3.7%).

The higher a firm increases its portfolio in terms of assets under management, it will get even more difficult for that firm to achieve high active share mainly due to limitations in the stocks that can be purchased.

If Berkshire decides to become a standalone fund, it would be the third-largest mutual fund and second to the S&P 500 ETF Trust (SPY) in the exchange-traded fund sector.

Significantly, Buffett accepts that his portfolio will not be as profitable as in the past, however, its active share that is 86% as per Validea shows that the holdings have its own uniqueness compared to the overall market.

Certainly, imitating Buffett’s approach of building a stock portfolio is not everyone’s cup of tea, as making concentrated bets that are often completely opposite of what the market says is often highly volatile. 

However, just by studying Buffett’s investing approach, long term investing, his discipline and patience is a priceless asset to hold for any investor.

Currently, the compound return for Berkshire is a staggering 20.6% compounded return, which means that by the end of 2018 equivalent to a 2,455,381.86% return $10,000 invested back in 1965 would amount to $247 million in dollars. 

As per Buffett, almost every investor bears losses from time to time, so while investing it is important to understand the power of compounding and invest with a long term perspective.

No doubt it will take years and some sort of uniqueness and aura to be one of the top stock investors, and replicating the success of someone like Warren Buffet will be extremely difficult. But Rome was not built in a day and likewise having a strategy based on Warren Buffett’s success mantra will definitely pay dividends in the future.

The below-mentioned stocks have been selected as per the quantitative model extracted from the book Buffettology and are an 80% match to the criteria. 

The quantitative model is a replication of Buffet’s core investing method of buying top-rated ventures with competitive moats at reasonable prices. Each of the companies below passes the model I run with at least an 80% score.

Apple (AAPL)

Buffett’s investment portfolio is not known for investing in technology firms, however, currently, Apple is Berkshire’s largest position. There is a competitive moat around apple mainly due to its 10 years of consistent profits and decade of high ROE & ROTC. Apple looks strong fundamentally as well.

Boeing (BA)

This is a classic example of Buffett’s investment strategy as he is known to buy shares of top companies when they go on sale. Currently, the stock price of Boeing has had a setback due to the 737 Max problems and the unknown aftermath of the underlying business. However, the long term earnings consistency, combined with strong returns on equity and capital are positive signs for Boeing in the long run.

Another positive, and similarity in Buffett’s investment model are that Boeing is currently buying back stock meaning that with less than two years of its earnings it can pay off its liabilities.

Mastercard (MA)

Over the coming few years, the stock of Mastercard has nice upward potential as per the calculation of two different expected future price return, and combine that with the fact that Buffett has a stake in the company it was a no brainer that this company suited the Buffett model mentioned above.

Monster Beverage (MNST)

Yes, even I was quite intrigued at first, especially knowing about Buffett’s affection for one of is the largest holdings, Coca-Cola (KO). Rumors of Coca-Cola possibly taking over Monster have been going on for quite a while now. Even if this deal is just another rumor, Monster had to make this list as its qualities are perfect for Buffett’s investing model. 

TJX Companies (TJX)

TJX, the owner and operator T.J. Maxx and Marshalls chains, is arguably a dark horse in the extremely competitive retail business. The company has shown that it is capable of generating a 15% return on retained earnings over the last decade. Also, TJX’s management is buying back stock from over a year now which is another positive.

Provided that TJX shares continue to be profitable and give good returns as it has in the past they show the potential to produce a 20% long term annualized return. 

Toro (TTC)

Known as of the best turf, snow removal equipment, landscaping and irrigation system manufacturers firm, with a $7.5 billion this mid-size company is one of the leading landscaping, turf, snow removal equipment, and irrigation system manufacturers. It is one of Berkshire’s best functioning operating companies. In the past decade, Toro’s earnings have risen every year, its 10-year average ROE is 36.7%.

 

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Safdarali Rizvi
Safdarali Rizvi the management graduate. Has been an avid book reader all his life so naturally loves playing with his words. His curiosity for discovering futuristic opportunities drives him to enlighten the entire Geekymint team with exclusive and intriguing news. He has a real passion for calisthenics and sports. His management abilities and hunger for learning brings tremendous value to our team.

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