2020 has been a wild year, especially in the market. March saw the worst stock market crash since the 2008 financial crisis and now, 6 months later, we are approaching market all-time highs (Dow 30,000 soon?). In a world where an estimated 30 million Americans are unemployed, many investments are trading high above their actual worth. With this environment, how do you make smart investment decisions? For answers, we must turn to the big man himself: Warren Buffett.
Pre-COVID strategies to find undervalued companies are largely obsolete. Many institutional investors understand that this growth is unsustainable, yet they are still making moves. While it is difficult to find those “diamond in the rough” companies, it is not impossible. However, before we learn how to invest like Warren, we must know what he is invested in.
What is Warren Buffett invested in?
Berkshire Hathaway, Buffett’s public company, Berkshire Hathaway, recently released its quarterly 13-F which outlined all of its outstanding positions. As of June 30, Berkshire Hathaway’s top holdings, by market value, were:
- Apple, Inc (AAPL)
- Bank of America Corp (BAC)
- Coca-Cola Co (KO)
- American Express Company (AXP)
- Kraft Heinz Co (KHC)
- Moody’s Corporation (MCO)
- US Bancorp (USB)
- Wells Fargo & Co (WFC)
- Davita Inc (DVA)
- Charter Communications Inc (CHTR)
You can find the full list of investments, as well as weighting of each company, here.
All of these companies are pretty recognizable and industry diverse. Should you then just make your portfolio a carbon copy of Warren’s and go from there? The short answer is no. This will not work for numerous reasons.
Berkshire Hathaway’s investments are dated by almost 2 months
While the company discloses its investments every quarter, the 13-F filing is released around 2 months after the end date. For the above companies, this was the company’s position as of June 30, 2020. At the time of writing, a month and a half has already passed. Warren Buffett is making investment decisions nearly every day, but we usually only know specifics about those investments every 3 months. Adjustments in positions are constantly being made, and Berkshire’s total investment in a company could change drastically in three months; you will not be able to keep up with such delayed information.
There is the option to closely follow the news and decipher how Buffett is adjusting his portfolio, however this is not investing. In order to be successful investing, you must emulate Buffett’s ideas and strategies, but not the stock picks themselves.
Warren Buffett is consistently looking for cutting-edge opportunities
Warren is a creative investor in that he tries to find value everywhere. Just recently, Berkshire has made $6 billion worth of investments in Japanese companies. However, we did not hear about this until after this has happened. As an individual investor you will always be late to this party, as there are complex institutional investors that instantly jump into whatever Buffett announces he is investing in.
As shown, do not try to copy Buffett’s individual investments, because you will not see the return that you expect. It should be our goal as an investor to reverse-engineer the decision process, not copy the decision itself. By getting an understanding of the fundamentals of his decision making, you can make Buffett-like investments without relying on Berkshire Hathaway’s announcements.
How to invest like Warren Buffett
Warren Buffett is a pioneer for the investing paradigm called value investing. Essentially, value investors will scour the market for what they think are undervalued investments, and buy them. They will then hold until a predetermined price that they believe is the true market value of the stock. Value investors get to this primarily through fundamental analysis. While it sometimes is more of an art than a science, fundamental analysis can help any investor uncover crucial details for an investment.
What is fundamental analysis?
Fundamental analysis is the technique of exploring and analyzing a company’s financial statements to make investment decisions. Fundamental analysis rarely involves chart analysis or price prediction. Value investors only care that a price is reasonable based on the company’s hard numbers.
There are many ways to understand and go about value investing; top Asset Management firms have complex models that analysts use to calculate price targets. Some retail investors build their own models to calculate fair market price. These models often rely on a number of assumptions that are as much of a guess as they are fact, and so I don’t recommend an individual to try and replicate valuation models. There are other ways to go about fundamental analysis, however.
In Pick Winning Stocks in 5 Steps, I detail out every step a value investor like Warren Buffett goes through in order to choose successful investments. While every investor has their own tweak to their investment strategy, these 5 steps form the basis of all value investing. In order to see success like Buffett, you must think like Buffett.
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The basics of fundamental analysis
In order to be a successful value investor, you must have a base understanding of finance. You do not need a formal degree, nor do you need to know the more intricate topics. However, fundamental analysis hinges on analyzing the following financial statements, each with a specific purpose:
- Income Statement (Profit and Loss Statement)
- Balance Sheet
- Statement of Cash Flows
The income statement outlines how a company performed over the reported time period. Did the company turn a profit, or did it show a loss? All of this is found in the income statement (also called the profit and loss statement). Similarly, the balance sheet gives you a direct look at a company’s current financial position. The amount of debt on the books, the total cash a company has, the value of the company’s assets, and owner’s equity is all found on the balance sheet. Finally, the statement of cash flows gives details into where a company is generating and spending cash. Not every cash transaction is recorded on the income statement, and this serves to reconcile any differences.
In your analysis, how should you use these items? There are many ways to interpret financial statements, however I recommend you use the following ideas as a starting point:
- How much top-line revenue has the company generated? Is this more or less than last year? If it is less, why did it fall?
- Is the company profitable? If not, what are the major expenses on the income statement?
- How much debt does a company have? How much is this compared to its profit? Did the company take on more debt than last year?
- How much cash does the company have on hand? Where is cash being spent?
All of the above is analyzed under the key question of value investing: Is this a good investment at the current price? If a company seems to be trading at a price that is far too high given its revenue and profit, value investors will not invest. If the price seems fair, or even low, then they will consider buying in.
As mentioned above, these are only starting points. Fundamental analysis is extremely deep, and I go into further detail in Pick Winning Stocks in 5 Steps. Get it here now for 25% off!
Succeed like Warren Buffett
In all, there is far more to Warren Buffett’s investment philosophy than this short article. Warren has literal decades of experience, where he capitalized on his winners and learned tremendous lessons from his losers. In your investment journey, it is important that you understand why an investment might have succeeded or failed. Every mistake is a learning opportunity, and smart investors will learn how to not get burned twice.
As you begin delving into company financial statements, start thinking about value. Ignore the market noise and focus on the objective numbers. This is how Warren invests, and if you follow this guidance, it will pay off.