Warren Buffett's Priceless Investment Advice

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

If you can grasp this simple advice from Warren Buffett, you should do well as an investor. Sure, there are other investment strategies out there, but Buffett's approach is both easy to follow and demonstrably successful over more than 50 years. Why try anything else?

Two words for the efficient market hypothesis: Warren Buffett
An interesting academic study (PDF file) illustrates Buffett's amazing investment genius. From 1980 to 2003, the stock portfolio of Berkshire Hathaway beat the S&P 500 index in 20 out of 24 years. During that same period, Berkshire's average annual return from its stock portfolio outperformed the index by 12 percentage points. The efficient market theory predicts that this is impossible, but the theory is clearly wrong in this case.

Buffett has delivered these outstanding returns by buying undervalued shares in great companies such as Gillette, now owned by Procter & Gamble. Over the years, Berkshire has owned household names such as Gap (NYSE: GPS  ) , CarMax (NYSE: KMX  ) , and The Washington Post.

Although not every pick worked out, for the most part Buffett and Berkshire have made a mint. Indeed, Buffett's investment in Gillette increased threefold during the 1990s. Who'd have guessed you could get such stratospheric returns from razors?

The devil is in the details
So buying great companies at reasonable prices can deliver solid returns for long-term investors. The challenge, of course, is identifying great companies and determining what constitutes a reasonable price.

Buffett recommends that investors look for companies that deliver outstanding return on capital and produce substantial cash profits. He also suggests that you look for companies with a huge economic moat to protect them from competitors. You can identify companies with moats by looking for strong brands, alongside consistent or improving profit margins and returns on capital.

How do you determine the right buy price for shares in such companies? Buffett advises that you wait patiently for opportunities to purchase stocks at a significant discount to their intrinsic values -- as calculated by taking the present value of all future cash flows. Ultimately, he believes that "value will in time always be reflected in market price." When the market finally recognizes the true worth of your undervalued shares, you begin to earn solid returns.

Do-it-yourself outperformance
Before they can capture Buffett-like returns, beginning investors will need to develop their skills in identifying profitable companies and determining intrinsic values. In the meantime, consider looking for stock ideas among Berkshire's own holdings.

Over the past two years, Buffett has been selling off his stake in financials like Ameriprise (NYSE: AMP  ) and Bank of America (NYSE: BAC  ) . He’s been redeploying that capital in names like Sanofi-Aventis (NYSE: SNY  ) , a French pharmaceutical company with a broad product portfolio and about a 5% dividend yield. Buffett also owns shares of another high-yielding foreign pharma, GlaxoSmithKline (NYSE: GSK  ) .

We’ll have to wait for Berkshire to file a Form 13F before we know what Buffett’s buying today. In the meantime, another place to find great value-stock ideas is Motley Fool Inside Value. Philip Durell, the lead analyst for the service, follows an investment strategy very similar to Buffett's. He looks for undervalued companies that also have strong financials and competitive positions. This approach has allowed Philip to outperform the market since Inside Value's inception in 2004. To see his most recent stock picks, as well as the entire archive of past selections, sign up for a free 30-day trial today.

If investing in wonderful companies at fair prices is good enough for Warren Buffett -- arguably the finest investor on the planet -- it should be good enough for the rest of us.

This article was originally published on April 7, 2007. It has been updated.

John Reeves can't remember the last time he used a razor made by someone other than Gillette, and he wishes he'd owned shares in that company before P&G acquired it. John does not own shares of any companies mentioned. The Motley Fool owns shares of Berkshire Hathaway and Procter & Gamble. Berkshire Hathaway is an Inside Value and Stock Advisor recommendation. Wal-Mart and CarMax are Inside Value selections. GlaxoSmithKline is an Income Investor pick. Bank of America is a former Income Investor pick. The Gap is a former Stock Advisor recommendation. The Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (128)

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  • Report this Comment On February 15, 2009, at 2:22 PM, Rasbold wrote:

    In the 20's, if one said "it is as good as Morgan." That was an equivalent to "as good as gold". Warren Buffett is the new Morgan and beyond. Never doubt his word or positions, what may seems like some unlikely candidates for his money now, will prove to be some of the greatest ventures later.

    He is like the Kwisatch Haderach from Dune for the investment world.

    He is King.

    May Your Dow never Jones!

    www.whatwouldwarrendo.com

  • Report this Comment On February 16, 2009, at 9:09 AM, takomoto1 wrote:

    People have to be totally crazy to invest in KMX CARMAX the company just terminated 620 employees, after just increasing 401K contribution and retirement saying bad economy with 1.4B in surplus this company will go the same way as it parent company CIRCUIT CITY this company only thinks of its self and the ones that are yes people GMs with on education beyond high school corporate people with no college I wont go on this company isnt what it appears

  • Report this Comment On February 16, 2009, at 3:32 PM, TiltnSpill wrote:

    Takomoto1... I have to say your post made my brain hurt.

    "with no college I won't go on this company isn't what it appears"

    Is a triple negative still a negative?

  • Report this Comment On February 20, 2009, at 2:58 PM, casomega wrote:

    Take it easy fibreoptik.

    Thanks for your comments Homeontherange. It's always good to inquire about things taken for granted.

  • Report this Comment On February 20, 2009, at 3:48 PM, tradecraft46 wrote:

    I know Constellation and MidAmerican pretty well. When B-boy bought it, it was trading in the 20's and the hedgie told me it was worth 40 which gibed with my valuation. I was suffering from a 'doofus discount' because the owners, Corp Fin types, did not have a clear story.

    For Connie, well the honcho after Poindexer, Shattuck, ran it all with insiders he brought along. He was a 'little tin god' and had a very weak board which didn't get involved with the energy trading which finally nibbled him and it.

    Real opportunity comes when solid performers have goofy management, generally newbies.

  • Report this Comment On February 20, 2009, at 7:23 PM, drborst wrote:

    HomeOnTheRange, Thank You. MF is completely in love with Buffett. It takes something to say otherwise.

    That said, I get the feeling that his $40 Billion is more than just a little bit of luck. I just finished his biography, and after reading MF for a while, I was surprised at how often he was wrong. The guy baught a textile mill in the northeast (forming Berkshire Hathaway), invested in US Air, bet on shoe manufacturing in the US after China had already started taking over, and on newspapers.

    The guy has made a few leveraged bets that turned out incredibly well, and his "cigar butt" investing in the early days seems like he lived in a world where you could make easy money by reading more than everyone else and understanding value.

    The other takeaway, before you blow the Bufett myth, is this guy is probably the most persistent investor ever, and yet is also the most patient. He never stops, but he pauses when he thinks the market is overvalued.

    Finally, I think he is now using the carefully maintained Buffett Brand (which stands for more honesty than any other CEO offers today) and impressive balance sheet (which grew while he sat out the market these past few years) to invest in places where stability and financial backing increase value.

    He won't stop beating the market, who would you buy insurance from these days, Buffett or AIG? (which you point out, is effectively loaning money to BH at nice rates), and you can bet that he will price that preference into the cost of your insurance.

  • Report this Comment On February 21, 2009, at 9:16 AM, mdg40 wrote:

    It's completely misleading to mention Buffett, Madoff and Enron in the same sentence, the last two organizing multi-billion dollar frauds completely wiping out thousands of individuals, pension funds and destroying lives. Buffett has a proven track record and a reputation of complete honesty and humility, I too have finished his book, and was amazed at the single-minded determination he pursued his goal of making money for his investors. He has a tight network of like-minded friends that have all become rich over the years usually riding his coattails. He's not perfect by any means, but he's no Madoff

  • Report this Comment On February 24, 2009, at 5:15 PM, technowhiz wrote:

    All this fawning around Warren Buffett is a little hard to handle!

    Mr. nuffett is playing a very elaborate shell game...if he gets his bailout from the government he'll be the highest paid welfare recipient in the history of mankind...

    If you carefully read his latest financial statements (don't forget he controls Berkshire Hathaway) you'll see he can bail out his insurance company from his cash reserves and still handle the hit.

    Several of his senior executives are facing criminal charges and Buffett is smelling like a rose. You'll find confirmation of all this in his latest interim financial statements, buried deep in footnotes.

    If found out, America will realize Madoff is a choirboy compared to Buffett.

    President Obama should stay away from Buffett and recognize Buffett for the charlatan that he really is.

  • Report this Comment On March 04, 2009, at 12:15 AM, elwhappo123 wrote:

    Technowhiz:

    Are you kidding me, comparing the best investoer of the past 40 years to Madoff and Enron ? And using leverage is vastly different than investing policy premiums before claims are paid...its called float not leverage. By your measure every insurance company on the planet is a ponzi scheme..Is that what you are saying ?

    Second point: Buffet has never claimed to be superhuman stock picker..actually the opposite. His amazing returns (book value from 19-40,000) is due to limiting his losses on his mistakes and letting his winners run. The actual number of stock picking errors made compared to winners is irrelevant its the value of the calls that matter and in this he is inarguably way ahead !!...His main investing ability is emotional...he is patient, understands his own limits and doesn't let the prevailing thoughts govern his actions. To use a poker term...Buffet wins a few big pots and loses many small ones...this is what makes him a brilliant investor.

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