Warren Buffett's Best Guidelines for Value Investing in the AI Era

Barchart · 10/17 14:05

There is little doubt that the Mount Rushmore of investing greats would contain a likeness of Warren Buffett. From 1965 to 2023, his Berkshire Hathaway (BRK.A) stock appreciated at a compound annual growth rate of 19.8%. That’s nearly double the S&P 500 Index's ($SPX) annualized return of 10.2% over the same period.

Buffett built an unparalleled reputation over the years through his unwavering commitment to value investing, which has almost become a lost art.

He studied economics and finance at the University of Nebraska and the University of Pennsylvania’s Wharton School, and then went on to study at Columbia University. That’s where Buffett was introduced to the value investing philosophy of Benjamin Graham, widely considered to be the father of value investing.

Graham’s book, The Intelligent Investor, first published in 1949, provides all of the information needed to become a successful value investor. He also taught a course in security analysis that Buffett attended. Needless to say, Buffett was impressed by Graham’s approach, and has credited his former mentor with providing the framework for his own investment philosophy.

Buffett is also known for making long-term investments, holding onto companies for years or even decades, and avoiding frequent trading. This approach allowed him to take advantage of the power of compound interest, and gives the companies he invests into the time needed to grow and generate substantial returns.

His shift towards a more long-term approach, centered around finding great companies at a fair price, was influenced by his partnership with Charlie Munger.

With Munger’s push, Buffett began focusing on companies with a durable competitive advantage and a strong brand, or what he called a “moat.” Today, Buffett continues to apply this “great company at a fair price” approach to his investments, focusing on companies with strong growth potential and a durable competitive advantage.

A Value Investing Bear Market

Despite Buffett’s undeniable success, many investors today think value investing is dead. At the very least, it is wildly unpopular in today's artificial intelligence (AI)-fueled era, with the market dominated by the “Magnificent Seven” technology stocks.

However, there is reason to hope for a renaissance in value investing, according to Rob Arnott in a recent Financial Times article.

If you compare the ratio of the stock price to the book value of the cheapest 30% of stocks around the world stock market with the most expensive 30%, value is normally about 25% as expensive as growth.

Arnott said that, in the 2005 to 2007 period, value was expensive by historical standards, with that relative valuation level hovering near 40%. But by the summer of 2020, value stocks were left for dead, as cheap relative to growth stocks as they were at the peak of the dotcom bubble. Even now, value stocks are a mere one-eighth as expensive as growth stocks - a main reason for Arnott’s bullishness on value.

I often think - if I were still an advisor, how would I guide my clients in this current climate?

Well, who better to turn to than Warren Buffett for advice? Here are some of his guidelines that I’ve always followed…

Buffett’s Investing Guidelines

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

This first quote from Buffett highlights his focus on quality over price. He believes that it is better to invest in a company with a proven track record of success, a durable competitive advantage, and strong growth potential. However, Buffett is a true value investor. Buying great companies cheap is what value investing is all about.

This brings us to another Buffett quote…

“Price is what you pay, value is what you get.”

Buffett believes that it is more important to focus on the value a company provides, rather than simply its stock price. He looks for companies with strong fundamentals, durable competitive advantages, and a history of growth, and he is willing to pay a fair price for these companies, knowing that their value will increase over time.

Pay less attention to earnings per share, which can be “massaged” by management. Look for solid return on equity, high operating margins and low debt. In addition, look for companies that generate lots of cash and have a consistent operating history during the past 10 years.

Buffett likes buying companies with an “economic moat,” which gives a company barriers or protection from its competition. Examples of competitive advantages include high capital costs for rival companies to enter a business, a strong brand identity, or patent protection.

“Be fearful when others are greedy and greedy when others are fearful.”

This is actually my favorite Buffett quote, as it highlights his contrarian approach to investing, which is also mine.

Buffett often takes advantage of market panics to buy companies at a discount, knowing that their value will eventually recover. He also avoids overpriced companies, even if everyone else is investing in them, knowing that their value is likely to decrease over time.

I’ve found that going against the crowd can be an effective way to make a lot of money.

Another well-known investor, Jim Rogers, nicely described the art of patience and being a contrarian investor in a quote: "I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime."

Rogers' quote suggests that investors should wait for an opportunity to present itself and then pounce, rather than chasing the latest hot trend.

No one else can be Warren Buffett, but we can all incorporate some of his methods to become better investors.

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On the date of publication, Tony Daltorio did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.