Warren Buffett’s 4 Filter Approach to Investing

It’s common knowledge that Warren Buffett makes extremely fast decisions when it comes to investing. Even billion dollar deals decisions are quick. This method is essential for anyone looking to save a bit of time, and Buffett has spoken repeatedly on the fact that he doesn’t believe in wasting time on investment pitches. Usually, it takes an average of two to three minutes to decide if it’s worth the time.

But how does he make these important multi-million decisions so quickly? Simple. Buffett and his partner Charlier Munger have a quick four filter system that all investments must pass in order to be considered  a good deal.

Here are the four filters, which Buffett shared with a student in 2007:

Filter #1: Do you understand the business?

This is the most obvious thing that investors tend to overlook. After all, if you don’t understand the business, how can you possibly make any intelligent and informed decisions about the potential and success of the company? This is all about understanding your personal limitations and knowing what you are and are not comfortable with.

Filter #2: Does the business have a durable competitive advantage?

Fads and trends are extremely lucrative, but they usually don’t have the longterm returns that investors should be looking for. It’s important to invest in a company that is going to continue to grow and be profitable. Don’t buy something simply with the intent to sell it as soon as it rises in price. You want something that is going to continue to be competitive and hopefully dominate the market.

Filter #3: Does the business have trustworthy management?

While it’s important to invest in the company, not the management, the trustworthiness of the management has to be taken into account, especially when considering an investment pitch. If you don’t feel like the person is being upfront and honest, then it may be better to play it safe and miss out on an opportunity than risk everything.

Filter #4: Does the price make sense?

Buffett has been quoted numerous times saying that a great company at a fair price is better than a mediocre company at a wonderful price. If the price is too good to be true, it probably is. This is, for Buffett, also an ethics statement, as he seems more apt to pay a good price for a company than to steal it out from under someone in a hostile takeover.

Buffett and Munger have been using these same four filters since 1972, and obviously it is working for them as Buffett is the 4th richest man in the world, and Berkshire Hathaway, is worth several hundred million dollars in capital. This just goes to show that not everything has to be complex to be successful.

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