Durable Competitive Advantage: Buffett’s Checklist To Pick Quality Stocks
I’ve been studying a dozen financial statements of different companies these past few days to find out how successful value & growth investors like Warren Buffett choose winning stocks by themselves.
Warren Buffett’s investing style is based on finding companies with durable competitive advantage.
In my post about the Equity Bond Theory, I discussed a simple equation in determining if a stock is selling for a bargain or not. This time, I’ll share to you a simple guideline in determining if the company you are thinking to invest with has a durable competitive advantage.
How Do We Tell If A Company Has A Durable Competitive Advantage?
According to Warren Buffet, companies that have it contains these 5 basic characteristics:
- Sell a product or a service that is a basic necessity.
- Is in an industry with very little competition.
- Sell a unique product that doesn’t change much.
- Provides a unique service that’s difficult to replicate.
- Is a low-cost buyer and seller of products the public constantly needs.
- Spends very little or none at all on Research and Development.
If a company you choose contains most of these basic characteristics, it is possible that the company has a durable competitive advantage. But this is not enough. We need to analyze the company’s Financial Statements.
Here are 10 things you need to check in the financial statements to qualify a business’ DCA;
- High return on equity;
- High return on invested capital;
- Increasing historical earnings;
- Little to no debt (except for financial companies);
- Competitive product or service;
- No organized labor groups;
- Product or service increase along with inflation;
- Low operational costs;
- Business buys back its shares; and lastly,
- Retained earnings are used efficiently thus adding value to the business and therefore increases the market value.
There’s no point in continuing if these companies fail these first few indicators. If the company I’m analyzing passes these indicators, I now delve deeper into the Income Statements, Balance Sheets and Cash Flow Statement of the company looking for other indicators which will really prove the company’s durable advantage the Warren Buffet way.
As a newbie into the stock market and having value and growth investing as my strategy, I should teach myself these basic things and that’s why you should teach yourself too.
I’m not rushing in to buy stocks just because someone told me that this stock is going to rise or do good in the future.
We must analyze it within ourselves to gain full confidence of the stocks we are planning to invest to avoid emotional decisions in the future which will hamper our long-term goals.