Warren Buffett, often referred to as the Oracle of Omaha, is one of the most successful investors in history. He has a net worth of over $100 billion and is known for his long-term investment strategy and value investing approach. Over the years, many investors have looked to Buffett for guidance on how to select stocks. Understanding his stock selection principles can help investors make better-informed investment decisions and potentially achieve similar success in the stock market.
Why Invest in Fast-Moving Consumer Goods Companies?
In the world of enterprise growth, the end goal is to continually increasing net profit. The foundation for net profit to increase annually lies in the continuous increase of the main revenue, with no significant increase in costs. If a company’s main source of revenue does not increase, then in an extreme and rare case, the net profit can still increase by greatly controlling costs and expenses. However, this situation is not sustainable.
Sustainable growth is achieved when a company’s net profit increases significantly due to the continuous increase of main revenue. Main revenue increase is achieved by an increase in sales volume, product price increase, or both. The increase in sales volume largely depends on repeated consumption of the product. The product should not saturate quickly after purchase, but instead, be consumed quickly, creating a new demand. This will increase sales volume and main revenue.
Sustainable growth is impossible and will never happen in industries where there is a decline or saturation in demand. Fast-moving consumer goods companies can easily become growth stocks because they provide infinite and sustainable demand, creating conditions for an increase in main revenue. This is why Warren Buffet invests heavily in fast-moving consumer goods.
Why Invest in Super Giants of Monopoly Industries?
When there are ten thousand companies competing in the cola industry, although consumption of cola is fast and demand is unlimited, the large number of competing companies means that not all companies will see an increase in sales even if demand is growing and persistent. The industry’s demand may not translate into sales growth for the company you invest in. To ensure that your investment can absorb the huge demand in the industry, you must invest in a company that is the leader or super giant in a monopoly industry where there are few competitors.
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Renowned industrial economist Michael Porter once said, “The future of a company depends on the characteristics of the industry in which it operates. Only industries that are conducive to growth have the potential to produce good companies.”
The future of a company depends on the characteristics of the industry in which it operates. Only industries that are conducive to growth have the potential to produce good companies
Michael Porter, Industrial Economist
At the same time, the future growth of a company also depends on its position in the industry in which it operates. If a company’s position in its industry is clearly inferior, then even a good industry will not help. This is why Buffett invests in high-monopolistic oligopoly fast-moving consumer goods companies.
Why Investing in Light Asset Companies is Beneficial?
When it comes to investing in a company, the increase in revenue does not necessarily result in an increase in profits. The reason behind this is that if a company’s revenue grows, but its costs and expenses grow even more, then the profits may decrease instead of increasing. Only when the revenue grows significantly, while the costs remain stable or increase slightly, can a company’s profits increase.
This is the fundamental reason why Warren Buffett invests in light asset companies. Light asset companies have the basic characteristic of not having their costs and expenses increase in proportion to their revenue growth. After a small amount of expense, these companies can trigger significant revenue growth. On the other hand, heavy asset companies require a lot of investment to increase their revenue, which results in a large portion of their revenue growth being consumed by costs, expenses, and wages. This leads to the inability to generate profit growth.
Therefore, investing in light asset companies can be a wise investment choice. By doing so, investors can get a higher return on investment since these companies can generate more profits with a smaller investment. Additionally, these companies are more stable and less risky, making them a safer investment option.
In conclusion, it is important to consider the costs and expenses of a company when investing. Focusing on light asset companies can be a smart move since they have a better chance of generating profit growth.
Why Invest in Companies with Short Supply Chains?
Years ago, the Chinese milk scandal and the lean meat powder incident in the Chinese pork industry had a significant impact on the businesses and reputation of the companies involved. However, these incidents were not intentionally caused by the companies themselves. Instead, the problems were caused by the upstream suppliers and raw materials, which transferred the issues and troubles to the production companies, resulting in their difficulties and troubles.
Industries such as the Chinese dairy and pork industries have complex and uncontrollable supply chains, where problems with upstream suppliers directly affect the production companies. In contrast, companies like The Washington Post, American Express, and other heavyweights do not rely on raw material suppliers. They are service companies that operate on social infrastructure elements, which do not pose significant risks.
During the financial crisis, many mechanical manufacturing companies faced difficulties due to two factors. Firstly, the financial crisis caused a severe decline in demand, and secondly, these companies had large inventories of metal materials such as steel, copper, and aluminum. Since demand shrank, the inventory could not be quickly transformed into goods. The prices of metal materials also dropped significantly due to the financial crisis, causing significant material losses for many mechanical manufacturing companies.
Famous mechanical manufacturing companies such as ZPMC were heavily hit by the financial crisis. The root of the issue is that their supply chains are long and complex, and many mechanical manufacturing companies are a link in a very complex supply chain. Any problem occurring upstream or downstream in the supply chain immediately affects the companies in the middle.
On the other hand, looking at Buffett’s stock portfolio, this issue does not exist. All the stocks he holds are directly facing the mass market, and the products they offer are essential and necessary. Regardless of financial crises or any changes in society, the products offered by companies in Buffett’s stock portfolio are not easily affected. This stability in the operating environment of Buffett’s stock portfolio is due to the companies’ short and simple supply chains, which have a lower probability of experiencing risks and are less dependent on the environment. Since they do not rely heavily on upstream or downstream suppliers, they are less susceptible to being affected when the environment becomes turbulent.
Investing in companies with short supply chains reduces uncertainty and increases certainty, as the probability of risks occurring is lower. Complex and lengthy supply chains have a higher probability of experiencing risks and are more dependent on the environment. Therefore, Buffett chooses to invest in companies with short supply chains to avoid risks and increase certainty.
Why Invest in Companies with Single Products and Simple Processes?
Investing in companies with single products and simple processes is all about ensuring certainty and reducing risks. If you have been doing the same job for decades, you could do it with your eyes closed. You are so familiar with the job that there is nothing you do not know about it, making it almost impossible to make mistakes.
Simple production and simple processes reduce the likelihood of errors, while long-term operation allows companies to accumulate experience and capabilities in the industry, making it difficult for serious mistakes and errors to occur.
This greatly reduces the probability of uncertain and unexpected events occurring in the invested companies. Short industrial chains, single products, simple processes, and long-term operation provide comprehensive certainty and guarantee for the investment object and eliminate various potential and unpredictable risks.
Looking back at Buffett’s major stock selection principles, they can be simply divided into two categories. The first is to ensure the growth of the company, and the second is to ensure that the company has high certainty and low risk or no risk. The dialectical unity of the two principles has enabled Buffett to select investment objects with high certainty, low risk, and sustainable growth.
The fundamental view of securities investment is that the investment object is only optimal when it is high-growth and low-risk. Buffett’s stock selection focuses on both growth and low risk. He thinks from the perspective of both risk and growth, and the combination of the two creates Buffett’s investment myth.
The best investment opportunity is the one with the minimum risk and the maximum return. Seek the optimal from the relationship between risk and opportunity. Return and risk are interdependent, and they can never be separated. Only by knowing how big the risk is and overcoming it can you obtain the return. If you do not pay attention to the risk and directly pursue the return, you will often fall into a trap. The return is the gain after crossing the risk, and the risk is the loss when the return cannot be realized. They are one and the same and interdependent. We must look at them from both aspects of risk and return.
As we can see, it is essential to ensure both high growth and low risk. Buffett focuses on the growth of companies, but he also pays more attention to the stability and certainty of their growth. Instability and uncertainty are risks. Half of Buffett’s stock selection philosophy is used to pursue growth, including the principles of fast-moving consumer goods, super oligopoly, and light assets, while the other half focuses on low risk, including the principles of short industrial chains, simple product processes, and single products.
In investment practice, we must adhere to the combination of growth and risk factors and pay equal attention to both while maintaining a dialectical unity. Buffett attaches equal importance to high growth and low risk in his stock selection principles, which is also the root cause of the long-standing dominance of Buffett’s heavily-weighted stocks.
In fact, the principles of buying large, buying monopolies, and buying light assets are not only to ensure the growth of the company but also to reduce its risk. Highly monopolistic large companies have stronger risk resistance than small companies, which is a basic industry knowledge. Light assets have fewer risks and problems because of fewer assets involved, which is beneficial for rapid growth and is unlikely to generate excessive problems and risks.