Tag: value investing criteria

How to Find Stocks like Warren Buffett – Part 4

This is the final part in the series “How I Beat The Market”.

People say that Buffett is so successful because he doesn’t follow the masses. He uses his own common sense to make decisions even if that means going totally against the grain and what’s perceived as “normal”.

In the last post, we read about how he doesn’t follow the general public’s perception of stock diversification. He has often put all of his eggs in one basket. It’s also interesting to know that Buffett doesn’t really care about the daily, monthly, or even one-year ups and downs of the market. He is more focused on the long term, around 5 years and beyond. At the current time of writing, he doesn’t even have a computer or stock ticker in his office.

After reading his books, you’ll realize that the daily, monthly, quarterly, and even 12-month ups and downs of the market are mostly based on the emotions and fears of people. The majority of this kind of investing is speculation. Analysts, advisors, and investors who are attempting to predict and time the market movements are relying on speculative methods.

There is no accurate way to predict what will happen in the market. However, when you start looking at the previous 5 and 10 years of historical data of a particular stock, you are better able to see good companies to possibly invest in. This long-term view is how Buffett finds his winning companies. He has a set of data or financial metrics that he looks at to compare each stock. He also has his set of common-sense questions that tell him if the company has a competitive advantage over its competitors.

You can learn about these financial metrics and questions by reading The Warren Buffett Way and the Buffettology series that I mentioned in the previous posts. While I was reading or listening to these audiobooks, I was shocked that they were giving away the investing secrets of Warren Buffett and Benjamin Graham.

The other thing I was surprised about is why more people don’t just implement their methods to invest in their own portfolios. Then I realized that some people will probably be scared away by the financial metric terms that are used to analyze a stock, such as: ROE, ROIC, GPM, PEG Ratio, etc. or (Return on Equity, Return on Invested Capital, Gross Profit Margin, Price/Earnings to Growth Ratio, respectively). Really, these terms aren’t anything to be afraid of. They are just fancy ways of explaining the chance of income and expenses for a company and variations of it. Buffett has some basic guidelines in comparing these metrics.

For example: These are some of the criteria that Buffett looks for when analyzing stocks: Return On Equity: 15% or more. Return On Invested Capital: 15% or more. Gross Profit Margin: 30% or more. PEG Ratio: less than 1. So you can basically just look up these metrics which can be found online and see if the company you’re analyzing meets the requirements.

However, this can be very time consuming especially when done manually. That is why people use websites and software programs to automatically calculate and compare these metrics. But even with these websites and software programs, people still fail to implement Buffett’s strategies for success. Why is this? He doesn’t really keep his investing strategies a secret. You can read about them in recommended books about Buffett or in his annual reports, you can listen to lectures and interviews by him and his investing partner Charlie Munger. They basically tell you how they invest and what they look for in a company. I believe the problem is that their method of investing uses too much common sense. It’s simple and straight forward and people think that there must be some bigger, better, secret way to investing that they will surely discover.

I was not too confident in my own abilities to analyze stocks. So I simply wrote down every criterion that I learned about in regards to Buffett’s analysis methods. I also noted the analyzing metrics and formulas that his mentor Benjamin Graham implemented. I put a combination of the most important of these metrics and formulas into a Microsoft Excel spreadsheet and started testing them with historical data. In other words, I would act as if I was investing in stocks 5 years ago. I would analyze different stocks from 5 years ago according to Buffett’s and Graham’s requirements. If the stock passed all the requirements, then I would mark it as a “stock to buy”.

After analyzing about 100 stocks, I ended up with only 2 stocks that were considered as a “stock to buy” according to my analyzer. I then calculated the Annualized Return I would have made if I had bought the stocks 5 years earlier and sold them on that current day. One of the stocks showed an annual return of over 50% per year for 5 years. The other stock showed an annual return of around 15% per year for 5 years. This was very exciting for me because it made me realize that copying Buffett’s and Graham’s strategies might actually work.

However, I would need to test many more stocks over multiple periods of time. Doing it manually wouldn’t work because it was taking me such a long time just to analyze each stock. So I decided to make a fully-automated Microsoft Excel spreadsheet, which I could load with around 500 stock symbols from the S&P 500 to automatically pick the winners. Then I could also see how the winning stocks performed over the next five years.

To my amazement, my analyzer picked a small combination of stocks that beat the S&P 500 almost every time. I ran tests of the S&P 500 stocks from all months over all different time ranges and it was proving that by following Buffett and Graham’s value investing method of picking stocks, I was reducing my risk by giving myself an important margin of safety and also increasing my chances of beating the market.

To “beat the market” or beat the S&P 500 is no easy task as I’ve found out from research. It turns out that Warren Buffett’s record of beating the market is a bit of a phenomenon that can’t easily be explained. Some people have even tried to say that it was luck, but statistical analysis has proven that there is a slim-to-none chance that Buffett’s consistent winning record could be based on luck. It’s clear that he has an investing system in place that works and it works extremely well. I’m no financial advisor or stock genius. I simply put this same type of system into an easy-to-use automated spreadsheet and I’m happy to say it works very well.

How well does the analyzer work?
Consider the fact that the analyzer has consistently beaten the S&P 500 month after month for 10 years of historical data analysis.

Why is it so important to beat the S&P 500?
The S&P 500 is a benchmark that many investors and financial advisors try to beat each year as a sign of success. Many consider the S&P 500 as the best representation of the American stock market as a whole. How hard is it to beat the market? This is an estimate of a normal financial advisor’s or investor’s chance of beating the market over a number of years: 
…and at 30 years, let’s just say we have a zero percent chance.

Rare but not impossible
As you can see, it’s not impossible to beat the market. However, most people base their investing off of speculation and emotions. If you use a concrete and common-sense system for investing over the long term, it is very possible to give yourself the ‘house advantage’ to beat the market year after year, just like Warren Buffett, Charlie Munger, Peter Lynch, John Templeton, and Benjamin Graham.

Take back control of your money
You’ve worked hard for your money, why let someone else gamble foolishly with it. Invest in a smart, common-sense way that is based objectively on proven historical stock data and not on emotions and speculation. I fully recommend value investing as a safe and logical approach to stock investing.

If you want to learn more about Value Investing, I recommend you start by reading or listening to the audiobook titled The Warren Buffett Way by Robert G. Hagstrom. You can also check out my free stock spreadsheet and see how it analyzes individual companies according to Graham’s and Buffett’s investing strategies.

Thanks for reading and here’s to beating the market!
-Grant