Let Me Save You $1.7 Million

So you want to pick Warren Buffett's brain. Who could blame you? He has, after all, been at the helm of Berkshire Hathaway (NYSE:BRK-B) for decades, racking up a rather impressive average annual gain of 20.3% in book value per share from 1965 to 2008. If you don't think that's impressive, consider that the S&P 500 averaged just 8.9% in that period. The S&P 500 could have turned a $1,000 investment into $42,600, while the rate at which Berkshire Hathaway grew book value would have turned $1,000 into $3.4 million.

Given a chance, you'd love to sit down with the great investor and learn from him. You want to ask for some advice that will guide your investing and improve your results. It's a worthy goal, but let's face it -- it's kind of hard to make it happen. Even though he auctions off a lunch with himself each year, to raise money for a favorite charity, it's pricey. This year, the lunch bill came to $1.7 million.

So let me offer you some of Buffett's food for thought -- even if it comes without the million-dollar meal.

The goods without the food
If you were with Mr. Buffett, you might ask, "What kind of businesses should I look for?" Well, here's his answer, from his letter to shareholders from 1992: "The best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return." You can find companies like that by looking for high returns on invested capital (ROIC). Here are some companies with high ROIC numbers that have earned four- or five-star ratings in our CAPS community of investors:

Data: Motley Fool CAPS and Capital IQ, a division of Standard and Poor's.

Mouthwatering economics
In 1991, Buffett noted that "We continually search for large businesses with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements."

You can develop this kind of focus, too. Stick to industries and companies you understand (which might mean excluding the insurance or energy industry, for example, if you don't understand exactly how they make their money and how various companies are positioned within them. Look for sustainable competitive advantages, such as Wal-Mart's ability to negotiate very low prices, or a pharmaceutical company having a bunch of billion-dollar drugs with many years before their patent protection runs out.

For mouthwatering economics, look for compelling business models, such as an online auction-based marketplace, where the company holds no inventory but just takes a cut of lots of transactions. And look for strong financial results, such as Johnson & Johnson's 21% net profit margin, its dividend yield of more than 3%, and the 12% average annual growth rate of its dividend over the past five years.

On diversification
Maybe, during your wished-for session with Mr. Buffett, you would ask him about whether you should have a diversified portfolio or not. Well, look no further than his 1993 letter to shareholders, in which he explained that unsophisticated investors should spread themselves thin, investing in lots of stocks and spacing out purchases over time. He noted what we've also said for many years, that "By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals."

Yet for "know-something" investors, he recommended limiting your stocks to five to 10 "sensibly-priced companies that possess important long-term competitive advantages." Personally, I would suggest here that only very skilled and confident investors should aim to have as few as five holdings, because that puts a lot of weight on each one. Perhaps aim for eight to 15, or even 20, otherwise. Or opt for a well-managed mutual fund instead.

Open book
One of the nicest things about Mr. Buffett is how open he is, and how willing he is to share his investing guidance. Of course it would be great to share a meal with the guy, and to ask him questions -- but you can save $1.7 million by just taking the time to read his thoughtful (and often amusing) letters to shareholders, which are available to all, for free.

Learn more in these articles:

• 3 Stocks on Buffett's Wish List?
• Warren Buffett's Priceless Investment Advice
• Buffett's Wrong: 5 Companies That Beat His

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