How to invest like Warren Buffett: His philosophy and some of the UK shares hed like the look of

By Ed Page Crof t PUBLISHED: 08:41 GMT, 10 May 2013 | UPDA TED: 14:47 GMT, 13 May 2013

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In the pantheon of investing legends Warren Buffett stands tall as one of the most successful investors the w orld has ever seen. His accumulation of a $50 billion fortune has made him a symbol of all American capitalism w hile his frugality and commitment to charity have earned him admiration from all sides. As the founder, chairman and CEO of US conglomerate Berkshire Hathaw ay, Buffett has the resources at hand to make multi-billion dollar market-moving investments. Yet, the principles behind his strategies have not actually changed much in more than 60 years of investing. In the fifth article in this series, Ed Page Croft, mastermind behind guru investing strategy w ebsite Stockopedia, looks at how Buffett has consistently delivered startling returns using an age-old formula and some common sense rules.

Coca-Cola: Penelope Cruz swigs from a bottle of coke, a brand Buffet had down as a cash-generating 'inevitable'

Learning to invest the Warren Buffett way

Among the reams of books w ritten by investing legends espousing market beating strategies, tips, tricks and complex mathematics, you w ont find any w ritten by Warren Buffett. Yet the 82-year old Sage of Omaha has earned a place in the heart of an adoring American public through the w it, candour and humility displayed in the shareholder letters he has w ritten to Berkshire Hathaw ay shareholders at the end of every financial year since 1977. These letters are must-read for anybody w anting an insight into the mind of the w orld's greatest investor w hile leaving a trail of w isdom for those w ho w ish to emulate him. Warren Buffett has been an astonishingly successful investor. Over 48 years his investment vehicle, Berkshire Hathaw ay, has delivered a compounded annualised gain of 19.7 per cent to shareholders, compared to an S&P 500 market index return of only 9.4 per cent.

Little w onder w hy its A shares now trade at a value of over $160,000 each w hile the companys shareholder meeting has become something of a cult, attracting up to 40,000 sw ooning disciples annually. While Buffett has clearly proven his financial genius in accumulating such extraordinary w ealth, many now agree that his pow ers are firmly on the w ane. In fact, Buffett himself has admitted that 2013 could w ell be the first time that Berkshire Hathaw ay w ill be beaten by the S&P 500 index over a five-year period. It seems that the great man may have finally become a victim of his success as he now struggles to find opportunities to match his $50 billion cash hoard. But there is hope for those w ith lesser fortunes w ho w ish to emulate the great man. Buffett himself once said, 'It's a huge structural advantage not to have a lot of money. I think I could make you 50 per cent a year on $1 million. No, I know I could. I guarantee that.' So lets take a closer look at w hat shaped Buffetts secret sauce and how individual investors might be able

to learn from it.

Schooled by the legends of investing - Graham and Fisher

As the son of a stockbroker, Buffetts early education w as investment heavy and by 1950 he w as attending Colombia Business School, w here finance analysts Benjamin Graham and David Dodd w ere tutors. Graham and Dodd had w ritten the hugely successful 'Security Analysis' in w hich they urged investors to seek out shares that w ere incorrectly valued by the market. Buffett became an advocate of their principle of buying misunderstood shares priced at a huge discount to their true value. Warren Buffett once said: 'The basic ideas of investing are to look at stocks as business, use the market's fluctuations to your advantage, and seek a margin of safety. That's w hat Ben Graham taught us. A hundred years from now they w ill still be the cornerstones of investing.'

WHAT NEXT FROM THE GURUS?

Many of us like the idea of buying great quality shares at cheap prices, but how do you do it? Next time w e look at how US hedge fund manager Joel Greenblatts Magic Formula can show you w here to look. Within a few years Buffett w as w orking for Grahams investment partnership before striking out on his ow n. A series of deals in the early 1960s saw him take control of struggling New England based textile company Berkshire Hathaw ay, a difficult investment that w ould teach him a few lessons. While he never departed from Ben Grahams principles of buying undervalued shares, he gradually learned that there w as more to value investing than simply buying the cheap, distressed companies clattering around at the bottom of the stock markets bargain bucket. While those so called 'cigar butt' stocks w ere regularly good for 'one last puff' of pure profit before they w ent broke, Buffett soon learned (via Philip Fisher) that there w ere far greater profits to be had in paying up for high quality businesses that retained their profits and stay in business - the kinds of companies that could compound shareholder value year by year. Berkshires distressed textile operations w ould ultimately be sold off at a loss, but provide an education w orth a fortune. As his philosophy developed tow ards '85 per cent Graham, 15 per cent Fisher' he gravitated tow ards investing in companies that show ed robust competitive advantages, outstanding management leadership and proven track records of grow th. Some of the illustrative investments that fuelled Buffetts fortune include the kinds of companies that he called inevitables cash generative brands such as Gillette, Coca Cola and American Express. In the case of American Express, Berkshire first bought its shares in the company in 1964, adding w eight to one of the Sages famous observations: 'Our favourite holding period is forever.'

What Buffett looks for in a great investment...

Earning the 50 per cent annualised returns in micro-caps that the early Buffett stalked requires a deep understanding of corporate accounting and w illingness to fish in dangerous w aters. How ever, there are safer w ays to hunt for the kinds of quality franchises that Buffett favoured in his golden period during the 1980s and 1990s.

These kinds of companies leave a trail of great financial results behind them that can be spotted as consistently high levels of cash flow , long term positive profit trends, industry beating margins and most importantly high returns on shareholder equity. The return on equity reveals how good a company is at generating a profit from the money invested in the business. Buffett realised that a high return on equity w as the real w ealth-generating engine in a business as the profits retained by the company can be reinvested at this rate back into the business, funding future profit grow th in a virtuous circle. The kinds of companies that can sustain a high return on equity often have a monopoly stranglehold on their markets, selling products or services that must be bought repeatedly by their customers, w hile having a freedom to set their ow n prices.

FREE FINANCE GUIDES

Undervalued Share Tips for 2013 (Guardian Stockbrockers) Where to invest your ISA in 2013 (MarketViews) Dubai still reaches for the sky, brought to you by HSBC (HSBC) How to invest for income - Free 16 page magazine (Aberdeen Asset Managers) How Equity Income Funds can safeguard your income from inflation (BNY Mellon)

The best companies often have either very strong barriers to entry, brands, scale advantages or netw ork effects that help sustain their great financials - these attributes help build the durability of a companys competitive advantage, or economic moat. Unfortunately, the types of stocks that have this profile often can become darlings of the stock market. Buying great companies at high prices can lead to very average results, so Buffett learnt to buy them during bad new s events w here the market puts them on sale. His famous trade to buy w arrants in Goldman Sachs during the financial crisis is a case in point. Buffett has never been one to speculate in startups, exploration stocks, blue sky projects or 'commodity' type businesses at the mercy of the market. These are the kinds of 'story' companies that private investors are so often suckers for on their w ay to the poor house. Buffett w as much happier to 'w ait for the fat pitch', for an investment that to fall w ithin his 'circle of competence'.

Hunting for Buffett-esque stocks in UK and European markets

Buffetts advice w as to start w ith the As and get to know all the great companies in the market w hile w aiting for the right price. He has been a huge advocate of reading 500 pages per day and searching through stock market directories looking for companies w ith promising financial profiles that are on sale.

These days one can scan the stock market much more quickly than w hen Buffett got started by using a pow erful stock screener loaded w ith the fundamentals and price histories of the stocks in the market. At Stockopedia w e currently track three different Warren Buffett inspired stock screening models based on hunting for stocks w ith the kind of financial profile w e've been discussing. Each of these strategies has outperformed the FTSE 100 to varying degrees since 2011. Among them, the Buffett-esque Sustainable Grow th Screen has produced a 21 per cent annualised return since 2011, and currently counts some famous brands and services amongst currently qualifying candidate stocks including Burberry, biotech company Abcam, Dominos Pizza and engineering group Kentz.

About Stockopedia and the guru investing strategies

Our investing guru series is being w ritten by Ed Page Croft and the team at Stockopedia. You can read This is Money's review of Stockopedia by Simon Lambert and more about the site at the links below . But first a w ord of w arning: The investing guru series seeks to explain the theories behind the great investors' success and highlight some shares that fit their methods. We highlight the modelled returns their strategies could achieve based on actual stock market performance, how ever, never forget that past performance is not indicative of future returns. It is also vital to consider that these and all other investment articles on This is Money are simply ideas and if you are thinking of investing they should only ever be a starting point for your ow n in-depth research before making a decision. Track the performance of all Stockopedia's GuruModel strategies Follow @stockopedia or @edcrofton Tw itter Stockopedia free 2 w eek trial and 50 discount for This is Money readers
* No fee for publication is involved between This is Money and Stockopedia for this column.

Com m ents (10)

Newest Oldest Best rated Worst rated View all I lov e this line in the article... "Buf f ett learnt to buy them during bad news ev ents where the market puts them on sale" y eah, because y ou don't want to be sued f or imply ing insider trading or market manipulation, which has been rif e in the US. A f ew wire taps here and there does tend to stop people promising 50% return these day s. - JJ , B-Stoke, United Kingdom, 14/5/2013 11:34 Click to rate Report abuse why is it that Dr graham and Dodds didn't make 50 billion as ther e student did Buf f it bonnet88 - bonnet88 , chingf ord, Albania, 11/5/2013 20:26 Click to rate Report abuse Rating 7 Rating (0)

Greka drilling - buy. - Tony Soprano , Elgin, 11/5/2013 14:49 Click to rate Report abuse Buf f et himself say s the av erage person should buy index f unds on a regular basis as they will not know enough to know what stocks to buy or when to buy them. - Django , London, 11/5/2013 03:33 Click to rate Report abuse Mr Buf f ett is a legend and spouts many wise public words. But he nev er giv es away his secret sauce. All that stuf f about "inv est f orev er" is just the obv ious bit to detract questions. His real secret sauce is kept priv ate. He knows that if he told y ou his genuine inv estment secrets, ev ery one would copy them in a f lash, and his inv esting edge and aura would be lost f orev er. By all means, listen to Buf f ett's excellent public adv ice, but be under no illusion that he is giv ing us the f ull picture. - Connect The Dotz , Woburn_England, 11/5/2013 02:50 Click to rate Report abuse Buf f et has enough wealth to buy companies outright. The only option small inv estors hav e is to buy property or buy Intel stock which y ields ov er 4% and y our likely to get y our money back or more. - anon , leeds, 11/5/2013 00:44 Click to rate Report abuse Its interesting that a lot of wanabees try to emulate Buf f et with mathematical f ormula when is'nt it obv ious Buf f et shoots f rom the hip with gut f eelings. Its seems so easy to him. - Greg Malay sia , Kedah, 10/5/2013 16:57 Click to rate Report abuse Yeah Agree, this article doesn't hav e a money shot at all. Please rename it as "Come buy our products to f ind out what Warren Buf f ett might inv est in." - Robert , Oxf ord, United Kingdom, 10/5/2013 13:26 Click to rate Report abuse Good on y ou Mr Buf f ett a most unpretentious man still liv ing modestly despite his wealth .... his share holder meetings are good old f ashioned af f airs ( with Mr Buf f ett and his second in charge Mr Charlie Munger acting as chef s cooking up the barbie ) Next time any DMV readers squirt some Heinz tomato sauce on y our f ood y ou will be adding to the Berkshire Hatherway cof f ers as Heinz was the latest acquisition in a v ery div ersif ied portf olio Rating 33 Rating 15 Rating 7 Rating 28 Rating 17 Rating 11

- Drug Free , Sy dney, Australia, 10/5/2013 11:49 Click to rate Report abuse So this is sort of like an adv ert but without the word 'Adv ert' at the start?................ during the gold rush it was the people who sold the shov els who became the Millionaires. - TB , Norf olk, United Kingdom, 10/5/2013 11:32 Click to rate Report abuse Share this comment The v iews expressed in the contents abov e are those of our users and do not necessarily ref lect the v iews of MailOnline. Power Portf olio Newsletters Guides Sav ings rates Money sav ers Calculators Rating 47 Rating 15

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FREE FINANCE GUIDES

Undervalued Share Tips for 2013 (Guardian Stockbrockers) Where to invest your ISA in 2013 (MarketViews) Dubai still reaches for the sky, brought to you by HSBC (HSBC) How to invest for income - Free 16 page magazine (Aberdeen Asset Managers) How Equity Income Funds can safeguard your income from inflation (BNY Mellon)

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