For nearly 60 years, Berkshire Hathaway (BRK.A 0.64%) (BRK.B 0.54%) CEO Warren Buffett has been dazzling Wall Street with his investing prowess. Though he's not perfect -- no investor is, for that matter -- the Oracle of Omaha has overseen an aggregate gain of 3,787,464% in his company's Class A shares (BRK.A) through the end of 2022. For context, that's 153 times the return of the broad-based S&P 500 over the same time frame, including dividends.
Warren Buffett's long-term success has earned him quite the following from individual and professional investors eager to unlock his secrets to long-term outperformance. But little do these investors know that Buffett spilled the beans on what he looks for in major investments nearly a half-century ago.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
One of the greatest treasure troves the Oracle of Omaha has bestowed on investors is his annual letter to shareholders. While this letter often summarizes the state of Berkshire Hathaway's operations, it also provides a look into the investing thought process of one of Wall Street's greatest minds.
In Warren Buffett's 1976 letter to Berkshire Hathaway shareholders, he laid out the four foundational criteria he and his team look for in major equity holdings.
1. "Favorable long-term economic characteristics"
For as long as Warren Buffett has been holding the reins at Berkshire Hathaway, he's preached the importance of long-term investing and analyzing businesses' performance over many years. It should come as absolutely no surprise that Berkshire's top holdings are businesses that offer sustained long-term catalysts.
For example, tech stock Apple (AAPL -0.57%) is leading with its innovation on multiple fronts. In the U.S., the company's iPhone has accounted for roughly half of all smartphone market share since introducing 5G wireless capability in the fourth quarter of 2020. Meanwhile, Apple is rapidly transforming into a services-oriented company that could see subscription revenue become its primary cash flow and profit driver by the second half of the decade. The need for subscription services and physical products (smartphones and laptops) continues to grow.
Credit services giant American Express (AXP -0.08%) is another example of a major equity holding with "favorable long-term economic characteristics." In addition to AmEx's payment-processing revenue growing in lockstep with the U.S. and global economies over time, American Express acts as a lender and can generate interest income and annual fee revenue from its cardholders. Being able to double-dip and play both sides of the aisle allows American Express to take advantage of disproportionately long periods of economic expansion.
2. "Competent and honest management"
The second foundational criterion for major equity holdings laid out by the Oracle of Omaha in his 1976 letter to Berkshire shareholders is "competent and honest management." While Buffett loves investing in businesses that essentially run themselves, he's well aware of the damage a poor management team can do.
For over 30 years, banking giant Wells Fargo (WFC 2.73%) was a fixture in Berkshire Hathaway's portfolio. However, that changed after the bank admitted to opening roughly 3.5 million unauthorized accounts at the branch level between 2009 and 2016. Between CEO turnover, a hefty fine from U.S. regulators, and the damage to Wells Fargo's reputation, the Oracle of Omaha and his team jettisoned this once foundational holding during the first quarter of 2022.
On the other hand, Warren Buffett has spoken fondly of what Jeff Bezos did as CEO of Amazon (AMZN -1.14%). Bezos stepped down as CEO in July 2021 but remains involved as executive chairman. In a 2017 interview with Becky Quick on CNBC's Squawk Box, Buffett exclaimed:
I'm amazed at the managerial talent of Jeff Bezos. I've been a constant fan, really, almost since he started. And the more I see him, the more impressed I've been with what he's accomplished.
Even though it was one of Warren Buffett's investing lieutenants who added Amazon stock to Berkshire's investment portfolio, the Oracle of Omaha has long regretted not jumping into Amazon stock earlier. In short, Buffett is a big fan of leaders who inspire trust and confidence.
Image source: Getty Images.
3. A "purchase price attractive when measured against the yardstick of value to a private owner"
The third criterion for major investments should surprise absolutely no one: Warren Buffett wants a good deal on a fantastic company and has been willing to sit on his proverbial hands until those once-in-a-blue-moon deals materialize.
For instance, the Oracle of Omaha and his team have been steadily plowing capital into media stock Paramount Global (PARA 1.48%) over the past couple of quarters. Although ad weakness is temporarily weighing on Paramount's legacy TV media segment, the company is enjoying lightning-fast revenue and subscriber growth from its streaming services. In fact, Pluto TV is the United States' leading ad-supported free streaming service, meaning it's uniquely positioned to excel if a recession does take shape.
When the U.S. economy is, once again, firing on all cylinders, $2-plus in annual earnings per share is very likely for Paramount Global. At roughly $20/share, that means the stock trades for a reasonably cheap 10 times (or possibly less) future earnings with a greater-than-4% dividend yield.
Another brand-name stock that passes the valuation sniff test for Warren Buffett is oil stock Chevron (CVX 0.75%). Even factoring in a softening in oil and natural gas prices since 2023 began, Chevron trades at roughly 10 times Wall Street's forecast earnings in 2023 and 2024. Considering that the global energy supply chain is broken due to three years of pandemic-related underinvestment and Russia's invasion of Ukraine, Chevron is appropriately positioned to take advantage of elevated energy commodity prices.
4. "An industry with which we are familiar and whose long-term business characteristics we feel competent to judge"
The fourth foundational criterion Warren Buffett uses when assessing whether a company can become a major equity holding for Berkshire Hathaway is his and his team's comfort level and knowledge of a specific industry. In other words, the Oracle of Omaha has a rather narrow research focus and tends to invest in sectors and industries where he and his team have authority.
There's probably no industry that Warren Buffett is more confident putting his money to work in than banking. Banks are cyclical businesses able to take advantage of long-winded economic expansions by growing their loans and deposits (i.e., the bread-and-butter of banking).
Bank of America (BAC 1.53%) is Berkshire Hathaway's unquestioned favorite bank stock. Although he appreciates the cyclical aspect of banks, BofA's interest sensitivity must have Buffett overjoyed at the moment. No U.S. money-center bank is benefiting more from the Federal Reserve's rapidly hiking interest rates than Bank of America.
The Oracle of Omaha and his lieutenants are also quite competent in assessing consumer staples stocks. Beverage behemoth Coca-Cola (KO 0.68%) is Berkshire's longest-held stock -- 35 years and counting.
Coca-Cola operates in all but three countries worldwide and has a top-notch marketing team. Coca-Cola may not be the growth story it was in the 1980s, but it continues to deliver highly predictable cash flow and has raised its base annual dividend in each of the past 61 years. This is the familiarity Buffett seeks from his major investments.
