The name Warren Buffett has basically been synonymous with value investing for many years now. He was a disciple of the value investor extraordinaire Benjamin Graham, who is also known as the “Father of Value Investing.” Because of this, Mister Buffett has become the most widely known investor, likely due to his ability to determine the true value of securities, and then purchase them for much less than what they are actually worth. This is a core concept of value investing. Buffett has said that “Price is what you pay. Value is what you get.
Labeling Warren Buffett as strictly a “value investor” is definitely an oversimplification of what the man does. The truth is that his overall investing strategy has quite a few different factors involved.
Actually, in a recent paper, three individuals from AQR Capital Management recognized that the main driving force of Warren Buffett’s major success over the last few decades has not been value. “The standard academic factors that capture the market, size, value and momentum premia cannot explain Buffett’s performance so it has to date been a mystery,” write Lasse H Pedersen, David Kabiller and Andrea Frazzini.
Early in their study, they said that they “find the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails.”
The group estimates that Warren Buffett applies about 1.6 to 1 leverage, and it is financed in part by the insurance float attained by Berkshire Hathaway. This group of individuals also recognized that Berkshire Hathaway’s public holdings between the years 1980 through 2011 averaged a beta of 0.77. This means that the stocks they purchased were quite a bit less volatile than the overall broader market.
It really isn’t all that surprising that Warren Buffett’s main catalyst to success was picking the safer stocks of high-quality companies. There is a Buffett style investment strategy that’s completely based on the way that Warren Buffett built his business. This strategy puts its major emphasis on quality companies, and this is even more important than specific value metrics. And these quality stocks also have a tendency to be a lot less volatile.
The overall Buffett style investing strategy requires that every company evaluated for purchase must have their earnings-per-share increase each year for at least a decade or more. Plus their annual earnings must provide them with the ability to pay off the entirety of their debt within a five-year span. The average ROI of each company must be 15% or more over the last decade as well. Every one of these signs are there to help you judge whether or not a business is of the highest quality.
It doesn’t really matter if you call it high-quality investing, value investing, high quality low beta investing or just low beta investing, the track record of Warren Buffett shows you in and of itself that this is an incredible approach that is definitely worth pursuing. So I recommend you do exactly that.