5 Stocks Warren Buffett Loves

Source: Wikimedia Commons.

How do you pick a great stock?

As a financial writer, and one that focuses on stocks in particular, that's a question that I think about a lot.

And each time I do so, I invariably come back to Warren Buffett, the chairman and CEO of Berkshire Hathaway (BRK.A -0.34%) and arguably the greatest investor of all time.

Unlike, say, a Peter Lynch, the former head of Fidelity's famed Magellan Fund, which he ran from 1977 to 1990, Buffett has adroitly steered Berkshire through every market cycle since the go-go years of the 1960s.

Under his stewardship, Berkshire's stock price notched a compound annual growth rate of 27.5% in the four decades between 1967 and 2007, handily beating the S&P 500 (^GSPC 1.20%) 19.8% performance.

How did he do it? His tactic was deceivingly simple.

The following table reveals Berkshire's five largest stock holdings. When it came to picking stocks, Buffett chose companies that had strong franchises and that, for one reason or another, were trading at a discount to their historical valuation.

Source: Insider Monkey.

He bought American Express in 1963 after one of its subsidiaries became embroiled in a fraud involving vegetable oil. But while the subsidiary ultimately declared bankruptcy, Buffett noted two things about its parent company. First, as described by the author Roger Lowenstein in Buffett: The Making of an American Capitalist, it wasn't going down the tubes. And second, its name was one of the world's greatest franchises.

A similar calculation underscored his decision to become Coca-Cola's largest shareholder. As Lowenstein recounts,

Coca-Cola was the sort of "simple" business -- one with pricing power and a protective "moat" -- that Buffett came to crave, particularly in the 1970s. ... [Its] main business was not selling Coke; it was providing concentrate and syrup to bottlers and soda fountains. Such a business (unlike bottling) required little capital. What's more, its name recognition was unique, especially overseas, where Coke outsold Pepsi four-to-one. In Buffett's terms, the brand name was a sort of a universal toll bridge.

And the very same type of mindset led him to buy a 10% stake in Wells Fargo in the midst of the savings-and-loan crisis. Because of fears of a downturn in the California real estate market, which Wells Fargo had significant exposure to, Buffett was able to pick up $290 million worth of its stock for an average price of $58 per share -- it had recently been trading for more than $80 a share.

The point is that while picking great stocks may not be easy -- it takes an extraordinary amount of research and behavioral fortitude -- it need not be complicated.