From 1964 to 2014, Warren Buffett's Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) produced an incredible 1,826,163% return for shareholders who bought and held for the long haul. To put that in perspective, this means that a $10,000 investment in Berkshire a half century ago would be worth more than $182 million today.
While Buffett's performance is amazing, everyday investors can use Buffett's approach to achieve market-beating returns in their own portfolios. With that in mind, here are nine Buffett investment principles that could turn your portfolio into a miniature Berkshire Hathaway:
1. Use the 50-year rule. Before investing in a company, ask yourself if the business will still be thriving in 50 years. This is precisely why Buffett has historically avoided tech stocks. I can say with 100% confidence that groceries, homes, insurance, and banking services will all be in demand for decades to come. On the other hand, will people still need laptop computers in the year 2065? Maybe, but maybe not.
2. Look for stable companies. There is no set definition of a "stable" company, and every stock has some degree of risk, but it's a good idea to check out a company's history before investing -- say, the last 10 years or so of its financials. Look for steadily increasing revenues and profits. If a company has an erratic history of profitability, such as earnings up 20% one year and down 20% the next, the business would likely be too unstable for Buffett's taste.
3. Take advantage when the market misprices good companies. Buffett's investment philosophy is predicated on the idea that there are bargains in the stock market just waiting to be found. For example, when all bank stocks were selling for fire-sale prices during the financial crisis, Buffett loaded up on those that he knew would survive and thrive over the long run. The same could be said right now with some of the leading stocks in the energy sector.
4. "It's better to buy a wonderful company at a fair price than a fair company at a wonderful price." This is perhaps my all-time favorite Buffett quote. Recently, Berkshire announced that it plans to acquire Precision Castparts for $37.2 billion, and admits they are paying a rather high valuation multiple. However, Buffett feels that Precision Castparts is a great business, and will gladly pay a fair premium to get it.
The same can be said of his choices during the financial crisis. Sure, Citigroup was trading at a deeper discount than some of the banks Buffett was buying, but he chose to pay a little more for quality. You shouldn't be afraid to do the same.
5. Buy stocks you would want to hold if the market were to close for 10 years. One of the worst habits a long-term investor can develop is obsessing over the daily moves in stock prices. Not only do daily price swings not matter much over long periods of time, but monitoring your stocks too closely encourages rash decisions such as panic-selling at a loss when the market is falling.
6. Invest in companies with a long history. Take a look at Berkshire's five largest stock holdings: Wells Fargo, Kraft Heinz, Coca-Cola, IBM, and American Express. All of these businesses have been around for a long time -- well over 100 years in some cases. Buffett likes to invest in mature companies that he feels are undervalued by the market, not growth companies that may or may not live up to their lofty valuations.
7. Identify a durable competitive advantage before buying a stock. Also known as a "wide moat," Buffett likes to invest in companies that have an advantage over their peers that will stand the test of time. Looking at the five companies above, this is relatively easy to see. Just to name a couple, Wells Fargo is the largest consumer-oriented bank in the U.S., and it has a history of financial discipline that has allowed it to consistently be more profitable than its peers. Kraft Heinz produces some of the most recognizable food products in the world. In fact, I'd bet that most people can't even name a brand of ketchup other than Heinz.
8. Maintain a focused portfolio. Buffett owns lots of stocks (44 as of this writing), but the majority of his portfolio is concentrated in just a few of them. In fact, the top five holdings I mentioned earlier make up almost 68% of Berkshire's portfolio. A portfolio that is focused on your most promising stocks gives you a better chance of beating the market -- after all, if you're going to spread your money evenly among 50 stocks, you may as well invest in an index fund and simply match the market's performance.
9. Look for shareholder-friendly management. Buffett prides himself on being a shareholder-friendly manager, and insists that the companies he invests in have a similar philosophy. There are some signs to look for that can indicate a company has its shareholders' best interests in mind. These include a clear and justified dividend policy, executives who own a lot of stock themselves, reasonable executive compensation, and open and frequent communication with shareholders.
The Foolish bottom line
Buffett has produced phenomenal results, averaging a 21.6% annual gain in share price over a 50-year period. In complete honesty, neither you nor anyone else are likely to match this type of performance over such a long time frame, but that doesn't mean you can't consistently beat the market and build the wealth you need to attain financial freedom. By incorporating some of the principles discussed here into your own portfolio, you could set yourself up to do just that.
Matthew Frankel owns shares of American Express and Berkshire Hathaway. The Motley Fool owns shares of and recommends Berkshire Hathaway and Wells Fargo. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola, short January 2016 $43 calls on Coca-Cola, short January 2016 $37 puts on Coca-Cola, and short January 2016 $52 puts on Wells Fargo. The Motley Fool recommends American Express, Coca-Cola, and Precision Castparts. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.