3 Investments That Fit Warren Buffett’s Most Important Investing Rules

Warren Buffett has three important investing rules that guide his decisions — are you following them?

| More on:
The Motley Fool

Little needs to be said about the success of Warren Buffett. The Oracle of Omaha has been the most successful investor of all time, growing his fortune to more than $50 billion before he started giving it away to charity. Seemingly every stock he’s invested in has become a winner, and his annual letters to the shareholders of his company, Berkshire Hathaway (NYSE:BRK.A, BRK.B), are filled with tidbits of information both informative and entertaining to investors everywhere.

While it’s impossible to boil down all of Buffett’s wisdom into a single article, his success is based on identifying just a few factors, zeroing in on what’s most important. Most of his stock purchases follow these same three different rules. Keep them in mind when choosing your next stock.

Pricing power

Let’s take a look at Buffett’s 1988 and 1998 purchase of Coca-Cola (NYSE:KO) shares. The company wasn’t particularly cheap, since in 1988 it had largely recovered from the New Coke fiasco. The price/earnings ratio was pretty much where it is now, close to 20. There were essentially two things going for Coca-Cola, and that was the potential for international growth and the strength of the brand.

Fellow value investors often talk about a company’s moat — the likelihood (or lack thereof) of a competitor coming in and stealing significant market share. A company like Coca-Cola has a wide moat. There are many people around the world whose first choice is a Coke, especially as developing nations get richer.

This means that Coca-Cola has pricing power. It can maintain their margins throughout challenging times because people are willing to pay a premium for the product. Don’t underestimate the importance of a company’s ability to continue to raise prices. One Canadian stock with terrific pricing power is Tim Hortons (TSX:THI). It doesn’t matter how much it raises coffee prices, people will keep going through the drive-thru for their morning cup of joe.

Timing

Many of Buffett’s greatest stock picking successes were bought at times when the market was severely beaten up.

In the crisis of 2008-09, Buffett was active, getting sweetheart deals from such powerhouses as General Electric (NYSE:GE) and Goldman Sachs (NYSE:GS) in exchange for a few billion dollars and, perhaps more importantly, attaching his name and reputation to a deal. Both those investments netted Buffett billions in profit.

Even when Buffett wasn’t as wealthy as he is now, he was still taking advantage of special opportunities. He purchased more than 10% of American Express (NYSE:AMX) in 1964 after it fell more than 50% due to the famous “salad oil” scandal. He recognized the potential for credit cards and the company’s solid financial footing were far greater than the negatives surrounding the scandal, and the rest is highly profitable history.

Barrick Gold (TSX:ABX)(NYSE:ABX) is down more than 50% for its recent high. Buffett would be far more likely to look at a company like Barrick than a company trading at new highs.

Easy-to-understand businesses

Buffett famously doesn’t invest in technology because he feels his understanding of the sector just isn’t good enough. This is an important lesson for every investor.

Just about every stock Buffett invests in is an easy to understand business. You won’t see any of his capital going into complicated hedging strategies or companies with many different types of business. Buffett keeps it simple, investing in stalwarts like food, energy, financials, or railroads. He understands those businesses, and limits himself to the sectors he knows best.

One Canadian company with an easy to understand business is Rogers Sugar (TSX:RSI). It sells one thing and it does it well. Fewer moving parts means there’s less that can go wrong.

Foolish bottom line

While I’d recommend every investor goes back and takes a look at Buffett’s annual chairman letters over at Berkshire Hathaway’s website, Buffett’s investing philosophy can really be boiled down to three simple rules. The difference between Buffett and the rest of us is how good he is at identifying companies that fit his criteria.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith owns shares in Rogers Sugar. 

More on Investing

question marks written reminders tickets
Dividend Stocks

Dividend Investors: Is BCE Stock a Buy Now?

BCE now offers a 7.9% dividend yield.

Read more »

A bull outlined against a field
Tech Stocks

Is a Bull Market Here? 4 Reasons to Buy Celestica Stock Like There’s No Tomorrow 

Celestica (TSX:CLS) stock has been a huge winner for investors this year, but there could be even more in the…

Read more »

Retirement plan
Investing

1 Retirement Savings Hack That Has Created Many Millionaires

Investors can retirement with $1 million in savings by investing in index funds such as the S&P 500.

Read more »

edit Taxes CRA
Dividend Stocks

CRA Money: 2 More Days to Boost Your Tax Refund!

Dividend stocks like Toronto-Dominion Bank (TSX:TD) can be great RRSP holdings.

Read more »

close-up photo of investor Warren Buffett
Stocks for Beginners

The Best Warren Buffett Stocks to Buy With $300 Right Now

These Warren Buffett stocks have long histories of growth, each offering their own reasons for why investors need them today.

Read more »

grow money, wealth build
Dividend Stocks

3 TSX Dividend Stocks With Yields Above 7% (But Are They Safe?)

These three dividend stocks all have ultra-high yields, making them some of the best to buy if you're looking to…

Read more »

oil and natural gas
Energy Stocks

3 Energy Stocks Already Worth Your While

TSX energy stocks could shine for much longer. Here's why Canadian Natural Resources (TSX:CNQ), Parex Resources (TSX:PXT), and another oil…

Read more »

Light bulb with jester hat perched on top
Dividend Stocks

3 Canadian Dividend Stocks With Payouts That Are No Joke 

Here are three top Canadian dividend stocks long-term investors would be remiss to ignore, particularly at these current valuations.

Read more »