Stock Selection criteria of Warren Buffett is unique and serves as a very powerful tool of making money in stock market. Buffett is very careful in what the company wants to invest. Find companies that are growing, and in areas that are fairly easy to understand. Companies can be divided into two types:
- Commodity-based Firms – These are companies that sell products in highly competitive markets where the price plays a key role in purchasing decisions of consumers. Examples of this type are the producers of textiles, raw materials for food such as wheat and rice, oil and gas companies, the timber industry and also the automotive industry.
- Consumer monopoly – The monopolies that sell products for which there is no real competition, because it is a registered trademark or a brand or similar non-specific, but that makes the product unique. Examples are corporate brand like Coca-Coca, media agencies and communication, and some companies that offer financial services.
Buffett does not buy shares of companies commodidy-based . These companies are highly competitive and dominated by the idea of production at the lowest possible cost. To effectively compete companies must spend heavily in improving production, thus having fewer resources available for the development of new products and new projects. In addition, these companies must have a high-level management to survive, but profits remain low because of price competition.
How to recognize a commodity-based society ? Buffett examines these characteristics:
the company has low profit margins (net income divided by revenues);
The company has a low return on equity (net income divided by equity);
there is little brand loyalty;
the industry has many producers;
the industry tends to have excessive production capacity;
profits tend to be irregular;
the company’s profits depend on the management capacity of using tangible assets efficiently.
Buffett is interested in companies that have a monopoly on consumers, are companies that have managed to create a product or a service that is somewhat unique and difficult to copy by competitors, and because there is a high brand loyalty, both because there is a particular niche market in which only a limited number of companies able to enter (an unregulated but legal monopoly such as due to a patent).
The exceptions to the rules of Monopoly are municipal utilities have a monopoly so that they are legal but highly regulated.
Monopolies can also adjust prices for inflation very quickly as there is a competition so small that it is impossible to keep prices under control.
From the perspective of the true value of monopolies Buffett is not in their tangible characteristics – such as trust in the brand, licenses and patents. You do not have to worry about making large investments in land, plant and equipment, and usually the products are low-tech. The result of these factors is that they tend to have higher capital flows and low debt.
In determining whether a company is a monopoly, Buffett raises the question : s and I had access to billions of dollars and the 50 best CEOs in the country, I could compete with this company?
If the answer is no, the company is likely to be protected from competition by a sort of monopoly.
Monopolies may be companies that sell products and services. Companies that produce or consume products that are ending soon and have a strong brand which must be used to attract consumers. The best example is the Coca-Cola, one of Buffett’s favorite holding for more than twenty years. The product is something that large stores, restaurants and other retailers simply need to make available. In addition, the brand loyalty exists throughout the world, not only in the United States. Other examples include leading newspapers, patents and pharmaceutical companies with drugs with a known brand, and restaurants with international brands such as McDonald’s.
The communications agencies that provide services need to reach consumers. All companies need to advertise their products to potential customers and many of the available media are facing a bit ‘of competition. These include advertising agencies, publishers, newspapers and networks in telecommunications.
Companies that provide consumer services, services that are always in demand. Most of these services requires little in terms of plant and equipment so that society does not need large amounts of capital and usually do not have to pay a heavy workforce. An example is credit cards, American Express and Dean Witter Discover in the first place