How to pick stocks like Warren Buffett

Berkshire has traditionally benefited from being able to sniff out companies with moats, including for these holdings

Ruth Saldanha 16 May, 2019 | 2:00PM

 

 

Karen Wallace: Berkshire Hathaway traces its roots back to a textile manufacturing company established in the 1800s. It's now one of the five largest corporations in the United States, along with Microsoft, Apple, Amazon, and Facebook. Berkshire is a holding company for about 50 other businesses, across a variety of industries--insurance, railroads, utilities, aerospace, restaurants, toys, and even apparel. 

One common thread woven through many of these businesses, though, is that they have economic moats.

Buffett once said, "The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors."

At Morningstar, assessing whether a company has an economic advantage, or moat, and how sustainable that moat is, is the cornerstone of our equity analysis. Companies with wide moats make great investments because they can fend off competition and earn high returns on capital for many years to come. 

What has traditionally benefited Berkshire has been the firm's ability to sniff out companies with moats, and take the excess cash flows generated by these companies and invest them back into projects that earn more than their cost of capital over extended periods of time.

Berkshire also has a collection of publicly traded stocks in its portfolio that also enjoy economic moats. It owns 400 million shares of Coca-Cola, which is nearly 10% of that company. 

As the one of the largest beverage companies in the world, Coca-Cola has earned a wide economic moat, thanks to its brand intangible assets and cost advantages created by its strong relationships with retailers and economies of scale. 

No trip around the exhibit hall would be complete without a stop at See's Candies, which Buffett has called the "prototype of a dream business." 

Why? Because it doesn't take a lot of money for this company to make money. The chocolate-maker's reputation for high quality products has allowed it continually increase prices and expand its sales with very few capital requirements.

The final piece of Buffett's winning formula is getting these great businesses at fair prices. High-quality businesses with reliable cash flows don't get cheap all that often, and Buffett is careful not to overpay. 

Our Morningstar Rating for stocks takes into account competitive advantage, margin of safety, and valuation, helping investors find companies Buffett would like at a good price.

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Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca