Warren Buffett announced his impending retirement on Saturday, amid a roughly 75-year career as one of the world’s most successful investors — accumulating a net worth currently estimated at $169 billion, according to Bloomberg.
How does he do it? Buffett, the 94-year-old CEO and chairman of holding company Berkshire Hathaway, likes to think about his potential investments like a “castle” when deciding which companies to back financially, according to his longtime friend and Microsoft co-founder Bill Gates.
“Warren likes to say that a good business is like a castle and you’ve got to think every day: Is the management growing the size of the moat? Or is the moat shrinking?” Gates wrote for the Harvard Business Review in 1996.
In this scenario, the castle’s moat equates to the basic fundamentals of a business — its “intrinsic value,” as Buffett has previously said. To determine intrinsic value, Buffett looks past a public company’s recent stock performance and evaluates factors like the consistency of its earnings, the state of its cash flow and the amount of debt it carries.
Buffett “likes to read all of its annual reports going back as far as he can,” wrote Gates. “He looks at how the company has progressed and what its strategy is,” and aims to determine whether the business can stand up to “the rigors of competition.”
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A business with little-to-no debt and consistently positive cash flow, for example, is usually music to Buffett’s ears. “If you attempt to assess intrinsic value, it all relates to cash flows,” he said at Berkshire Hathaway’s 1997 annual meeting. “The only reason for putting cash into any kind of an investment now is because you expect to take cash out.”
Once he’s satisfied with his research, Buffett “acts deliberately — and infrequently,” Gates wrote.
Buffett’s style of “value investing” involves thinking far ahead and holding onto assets for lengthy periods of time, regardless of any short-term market swings. He prefers business models that he believes are fundamentally sound, Gates noted, referencing a Buffett aphorism: “You should invest in a business that even a fool can run, because someday a fool will.”
Determining whether a business is foolproof is tricky. Buffett has said he’s drawn to companies that have cornered their particular market, or that “have a monopoly” on their specific business, like a newspaper in a town with no competitor publications, he told the Financial Crisis Inquiry Commission in 2010.
He also keeps an eye out for fundamentally sound businesses that he believes are managed in subpar ways — seeing them as opportunities to back the company and install stronger leadership, in the hopes of helping it reach its full potential.
“We are trying to figure out: Why is that castle still standing? And what’s going to keep it standing or cause it not to be standing five, 10, 20 years from now?” Buffett said during a Berkshire Hathaway annual shareholder meeting in 1995. “What are the key factors? And how permanent are they? How much do they depend on the genius of the lord in the castle?”
In the ensuing decades, Buffett has consistently espoused the same philosophy. In his most recent annual letter to Berkshire Hathaway shareholders, published on February 22, he wrote about his 2019 decision to invest in five large Japanese companies he believed to be undervalued — and his subsequent decision to increase his stake in those firms.
“We simply looked at their financial records and were amazed at the low prices of their stocks,” wrote Buffett. “As the years have passed, our admiration for these companies has consistently grown.”
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