Of all the longer-term investors out there, Warren Buffett is probably the most notable. It’s hard not to like this guy. Other than being an astute investor, he is also a notable contributor to various charities. Let's dive into the Oracle of Omaha's investing style and how to trade options using Warren Buffett stocks.
So, why you are reading this article? What you really want to know about Warren Buffett is his criteria for picking value stocks. Okay, here is a breakdown on what we have discovered in the search for Warren Buffett picks:
Warren Buffett is a value investor. That means he doesn’t participate in wildly running growth stocks—in fact, he was ridiculed for staying out of the tech boom in the late '90s. Of course, we all know how right he was just after the year 2000, when everything DotCom collapsed. Warren Buffett has a unique style when it comes to investing, so without writing a novel on the subject, let me get to the point of what he looks for.
Brand Recognition – One of his key criteria… Is the company well known? Does it have a stronghold in its core products with consumers? The company has to be a recognized brand in its industry for Warren Buffett to consider it as part of his holdings.
Earnings Consistency – Warren looks for a growing company with no negative years of earnings growth in past 5 years. If the company has had at least one year of negative earnings growth in the last 5 years, then it will not be considered. By the way, Long-term Earnings Per Share [EPS] growth indicates that the company is growing over time. The EPS of a company must be continually growing.
Long-term debt – This is the company's current long-term or multi-year debt structure. This could include mortgages, long-term bank notes, etc. In order to pass the Warren Buffett test, long-term debt must not be greater than 2 times net income. This is a liquidity measure which ensures that the company has not taken on too much risk through its borrowings.
Return On Equity – Return on Equity [ROE] measures the return on shareholders funds or shareholders equity. ROE is calculated by dividing the net profit by shareholder equity and multiplying it by 100 to express the result as a percentage. The higher the ROE, the better. Buffett requires a return on equity of 15% or more.
Capital Expenditure – Free cash flow per share is the amount of money that is free to be spent. It is cash flow minus all expenses. Buffett likes free cash flow per share to be positive.
Utilization of Returned Earnings – This is all about seeing if management is using retained earnings to increase shareholder value. In order to be increasing shareholder value, according to Buffett’s methodology, retained earnings should provide a return that is 15% or better, but he will accept if a company has a return that is better than 12%.