The name "Warren Buffett" is virtually synonymous with Wall Street success. As CEO of conglomerate Berkshire Hathaway (BRK.A -0.64%) (BRK.B -0.81%), Buffett has generated annualized returns of 20.3% for shareholders since 1965. That's more than double the 10% annualized total return (i.e., dividends included) for the benchmark S&P 500. It's over 2,700,000% better than the S&P 500, in aggregate, over the past 55 years.
How did Warren Buffett become such a great investor? It wasn't by having a perfect track record. The Oracle of Omaha has left tens of billions of dollars on the table by exiting positions in a couple of great companies (ahem, Disney) far too early.
Rather, I'd attribute Warren Buffett's success as an investor to the following six factors.
1. Buffett has maintained a relatively narrow research focus
The Oracle of Omaha has predominantly confined his research to the sectors and industries where he feels most knowledgeable. For Buffett, these areas are financial stocks and consumer staples. By focusing on the companies, topics, and trends that clearly interest him, Buffett has become quite adept at picking out winners in these two sectors.
In the rare instances when Buffett has strayed outside of his traditional focus, results haven't always been pretty. A recent example would be the $10 billion invested in preferred stock of Occidental Petroleum (OXY -0.54%). Although no one could have foreseen the coronavirus disease 2019 (COVID-19) pandemic and what it would do to the U.S. shale industry, Buffett was also aware of Occidental's debt load when acquiring Anadarko. Berkshire Hathaway has taken a bath on its Occidental investment.
2. He values proven brand-name businesses over potentially high-reward dart throws
Warren Buffett's success also stems from how he bets on time-tested businesses with clear-cut competitive advantages. Wall Street might be obsessed with growth stocks at the moment, but that's never been the Oracle of Omaha's forte. He'd much rather buy into mature, time-tested businesses and hang onto those investments for a long time.
Beverage giant Coca-Cola (KO 0.34%), which is Berkshire Hathaway's longest-tenured holding (since 1988), serves as the perfect example. Coca-Cola operates in all but two countries worldwide (North Korea and Cuba). It's one of the world's most recognized brands, and controls a whopping 20% share of the cold beverage market in developed countries. Coca-Cola also has over 20 brands bringing in north of $1 billion in annual sales.
Buffett loves businesses that require little maintenance. That's exactly what he's gotten with Coca-Cola.
3. Trustworthy management teams are a must for investment purposes
Buffett also values trustworthy and highly competent management teams. Motivated executives who constantly look to build shareholder value and maintain or grow existing market share are precisely what Buffett looks for in an investment.
Take Apple's (AAPL 0.68%) Tim Cook. He represents everything that Buffett seeks from an executive. Cook is pivoting Apple toward higher-margin services. He has also been leaning on exceptionally low-interest debt to fund aggressive share buybacks.
On the other hand, the CEO carousel at Wells Fargo (WFC 0.96%) is likely why the Oracle of Omaha has cut Berkshire Hathaway's stake by well over 300 million shares. Wells Fargo admitted to opening 3.5 million unauthorized accounts between 2009 and 2016 as part of an aggressive cross-selling campaign at the branch level. Consumer trust has taken a serious hit. Buffett's lack of faith in management appears to signal his intent to fully exit the position.
4. Dividend stocks are always top of mind
Investing in dividend stocks has also played a huge role in Buffett's long-term success.
Buffett's focus on buying mature businesses with clear-cut advantages means many of these companies are profitable and more likely to pay a dividend. Before the pandemic struck, Berkshire Hathaway was on track to generate about $4.7 billion in dividend income in 2020. This has changed considerably, with all airline stocks getting the boot and a handful of other income stocks reducing or suspending their payouts. Nevertheless, Berkshire's annual income stream remains well above $3 billion.
What's more, dividend stocks have historically outperformed those that don't pay dividends. A 2013 report from J.P. Morgan Asset Management found that companies initiating and raising their payouts between 1972 and 2012 delivered an average annualized return of 9.5%. Comparatively, stocks that didn't pay dividends only managed an annualized return of 1.6% over the same time frame.
5. He allows his investment theses to play out
Arguably the most powerful thing Warren Buffett does when it comes to investing is nothing. He buys into businesses that he believes are great and then sits on his hands for many, many years. In other words, the Oracle of Omaha lets compounding work its magic. The longer the investment horizon, the more powerful compounding can be.
Since 1982, Buffett has generated 99.6% of his current net worth ($376 million in 1982 vs. $86.5 billion in 2020). In fact, 80% of his net worth has been generated since 1996.
6. The Oracle of Omaha surrounds himself with competent investors
Lastly, Buffett's success has hinged on surrounding himself with a competent investment team. Right-hand man Charlie Munger and Berkshire Hathaway's investing lieutenants, Todd Combs and Ted Weschler, can help fill in the research areas that Buffett typically avoids.
For instance, Combs and Weschler have played a key role in boosting Berkshire Hathaway's exposure to the healthcare and technology sectors. Buffett isn't a big fan of keeping up on clinical trial data, and high-tech innovation has never been a top investment priority. With investors who are successful in their own right by his side, Buffett has dramatically increased Berkshire Hathaway's long-term chances of building shareholder wealth.