How to pick stocks the Buffett & Munger way | Value Research Buffett & Munger are known to pick companies with a moat. Here's their investment philosophy, wisdom and a ready-made stock list based on their approach.

How to pick stocks the Buffett & Munger way

Buffett & Munger are known to pick companies with a moat. Here's their investment philosophy, wisdom and a ready-made stock list based on their approach.

Warren Buffett and Charlie Munger are one of the greatest investing and business pairings of all time. Buffett developed his value-investing philosophy under the aegis of Benjamin Graham. On the other hand, Munger (a Harvard Law graduate) decided to switch to this profession after meeting Buffett. Before running their show at Berkshire Hathaway, the Buffett-Munger duo made their investments through their own partnerships and outperformed the Dow Jones Industrial Average index by a wide margin. Although both looked at investing from the lens of discount to intrinsic value, their philosophies differed significantly. While Buffett preferred to buy cheap businesses irrespective of their quality, Munger fixated on great businesses at a fair price. However, after getting together at the helm of Berkshire Hathaway, Buffett pivoted to Munger's approach.

How to pick stocks the Buffett & Munger way

Although their investment philosophy is simple to understand, it is not easy to apply. As mentioned in Berkshire Hathaway's 1976 letter to the shareholders, they focus on the following four factors:

  • Favourable long-term economic (business) characteristics
  • Competent and honest management
  • An attractive purchase price as against the yardstick of value to a private owner
  • An industry with which investors are familiar and whose long-term business characteristics investors are competent to judge

The above-mentioned four points form the bedrock of their investment philosophy. The concept of 'moat', popularised by Buffett, flows from the first point and the importance of investing in the business that one understands flows from the fourth point. To gain more insights into their philosophy, read their shareholder letters and also check out our free e-book 'Warren Buffett's investing wisdom'.

How to pick stocks the Buffett & Munger way

Here we have prepared a list of companies that we believe clear the first point mentioned above and have a strong moat. A 'moat' means a channel of water that surrounded the medieval castles in Europe. It made it difficult for enemies to raid the castle. In the same way, an economic moat makes it difficult for a competitor to invade a company's territory. In common parlance, a 'moat' equates to competitive advantage and barriers to entry.

Answering an investor query in 1995, Buffett said, "What we're trying to do is we're trying to find a business with a wide and long-lasting moat around it, surround - protecting a terrific economic castle with an honest lord in charge of the castle." He further added, "What we're trying to find is a business that, for one reason or another - it can be because it's the low-cost producer in some area, it can be because it has a natural franchise because of surface capabilities, it could be because of its position in the consumers' mind, it can be because of technological advantage, or any kind of reason at all, that it has this moat around it."

To arrive at the list of companies, we used both quantitative filters and subjective assessment. The quantitative filters applied were:

  • Cash flows from operations (CFO) to invested capital should be more than the cost of capital for 12 of the last 15 years (this filter was not applicable for finance companies)
  • Return on equity (ROE) of at least 15 per cent in 12 of the last 15 years

We applied these quantitative filters to our 2020 anniversary-issue list of companies with a moat. Then we assessed the companies that cleared and failed these filters. We ascertained whether their moats are still present. There were cases where a company cleared the quantitative filters, but we still decided to drop it, given its weakening moat. Similarly, a couple of companies failed the filters, yet we retained them because their moats are still strong.

To spot any new entrants, we applied the same filters above to the listed universe then judged their moat strength subjectively.

Here we present to you some companies that have a strong moat.

Also in the series:

How to pick stocks the Benjamin Graham way

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